The ‘Napster moment’
INDEX FUNDS: CHANGING THE INDUSTRY
The rise in passive investing corresponds with a decline in fees across the industry.
In just the last five years the amount of money invested in exchange-traded products globally has more than doubled. According to ETFGI, exchange-traded fund (ETF) and exchange-traded note (ETN) assets grew from $2.16 trillion at July 2013 to $5.12 trillion at July 2018.
Earlier this year, Morningstar showed the annual organic growth rate of US ETFs was 16% from 2008 to 2017. Meanwhile, mutual funds (US equivalent of unit trusts), grew just 2%.
Last year Moody’s predicted assets in index funds will surpass those in active funds in the US by 2024, as money continues to flow into passive products while active managers struggle to outperform.
In SA, only 5% to 10% of the money in collective investment schemes is held in index funds, but they’re slowly gaining more market share.
New reality
Investec Asset Management’s Richard Garland says the active management industry has yet to really come to terms with this.
“The passive managers in the US dominate flows. People say that when the market turns everyone is going to switch back to active.” He’s not so sure.
He believes index funds have fundamentally changed the industry, as they’ve shifted what people have become used to paying for asset management.
“All the advisors I speak to have 30% to 40% of their client’s funds in passive because they want to keep the fees down. That is not going away.”
Fee pressure
Morningstar’s analysis shows the rise in passive investing has corresponded with a decline in fees across the industry – in active and index funds. Investors are selling high-fee funds, which puts pressure on the entire market.
In the US, even active managers aren’t able to attract inflows unless they’re low cost. Flows into higher fee funds have been negative for the last four years.
“There is incredible pressure on fees for active managers and advisors,” says Garland. “To me this is a little like asset management’s ‘Napster moment’.
“The biggest shift I see globally is the move to passive and the focus on fees.”
Active isn’t dead
The challenge to the industry is, however, also an opportunity. The consensus is we’re moving into a lower-return environment, where markets won’t deliver the same kinds of numbers we’ve seen for 20 or 30 years.
Investing only in index funds may therefore not deliver the inflation-beating returns that investors need. Philip Saunders at Investec Asset Management believes the opportunity will be there for active managers to find ways of delivering that additional performance.
However, this will require active managers to offer products compellingly different.
“We have a more difficult world ahead of us in the next five to 10 years. The old beta cruising style of investing has passed its sell-by date … You really have to be a good active investor.”
Garland agrees
“Active is not dead, you just have to be good,” he says. “You have to be able to provide excess return against the benchmark. The only way you can do that is by looking different to the benchmark.”