By Roberto Lazzarotto, Global Head of Index Sales at Qontigo
The debate around active versus passive investing is intensifying amid strong growth in flows and assets at exchange-traded funds (ETFs) and index funds.
In 2019, investors withdrew 84 billion dollars from US actively managed funds and invested a net 472 billion dollars in their passively managed counterparts.1 In different asset types and geographies, one after the other, assets in passive funds are taking over those invested in active funds.
The move last year by the California Public Employees’ Retirement System (CalPERS) to cut off external equity managers unleashed many headlines and much commentary. The largest US pension fund is transferring nearly 14 billion dollars in managed assets to equity index strategies, according to reports.2
As inflows into passive funds garner attention and scrutiny, asset-management firms are considering how to react to new dynamics that may have more profound consequences than initially thought.
The smart investor
Last August, I made the point on this blog that the old debate centered around the arguments in favor and against passive and active investment styles is giving way to a more flexible and pragmatic approach. In the new investment landscape, the ‘smart investor’ employs active and passive in an opportunistic way and reaps the benefits of both.
A new report from Cerulli Associates supports this case.3 The global research and consulting firm says the active-versus-passive debate has become “redundant,” “as new approaches that combine both styles of investing continue to emerge.” Institutional asset managers now have the option to offer investment models structured around service provision rather than sell active equity funds, to generate fees, the Cerulli report argues.
Cerulli gave the example of thematic ETFs as a solution where asset managers can offer clients a combination of an active allocation within a rules-based, systematic approach.
“Straightforward active equity will continue to face strong headwinds, yet the distinction between active and passive is starting to soften and the trend for thematic exposure and the industry’s shift to services rather than products promises new avenues for growth,” said Justina Deveikyte, Cerulli’s Associate Director for European institutional research.4
While championing services such as allocation advisory resembles an act of self-promotion on the part of consultants seeking more and more to occupy this space in direct competition with the asset-management industry, it also reveals that this rise presents an opportunity for innovation and diversification.
Such a philosophy is precisely what underlies the creation of new tools like the STOXX iSTUDIOTM platform. Some might consider the offering of a self-indexing solution as a shot in the index provider’s foot. In reality, it is precisely the opposite. It is a clear recognition that the industry must continue to evolve to offer the best experience to the whole asset-investing ecosystem. In proposing value-added services to their clients, asset managers and consultants will be able to compare strategies and offer solutions, which in turn could be implemented with the cost efficiency of index-linked vehicles.
As the range of available data sets is becoming more accessible through systematic approaches, this will be a key point of conversation in the active-passive debate. In particular as sustainability and climate-related solutions become the norm across investment strategies. As such, investors would, for example, combine thematic or factor strategies with ESG screens.
The new focus
If passive investing is taking over where it can add efficiency, active managers will find a reliable business there where they can genuinely generate alpha. This includes specialized solutions, private markets, illiquid segments and alternatives; and in the increasing integration of passive offerings within their menu of products and services.
Everything is active
All and all, active investing will take a new meaning: much the stock-picking of old times, but also value-added active allocation decisions and customized servicing.
Indeed, asset allocation is for many the core ‘active’ decision and a segment conducive to added value. At a European investment conference in Paris organized by Societe Generale last November, panelists noted that as much as 90% of a portfolio performance could be attributed to the selection of assets, index choice and static factor exposure.5
That means that when an investor buys an ETF, not only are they buying an entire market — they are also actively choosing an asset class, geography, an index methodology, a style and a factor exposure and the timing of the purchase. There is nothing passive about those choices.
If passive strategies are growing in assets with low-cost beta products that enable market access, active asset managers can step up the game where they can truly deliver alpha. For the end client, this continues to be a beneficial development.
1 Refnitiv data in ‘U.S. Passively Managed Funds Outdraw Actively Managed Funds in 2019,’ Jan. 24, 2020.
2 Chief Investment Officer, ‘Almost $14 Billion Pulled from CalPERS Equity Managers,’ Dec. 16, 2019.
3 Cerulli Associates, ‘The Cerulli Edge ― Global Edition.’
4 Cerulli Associates press release, ‘Active Equity Funds Set to Continue Evolving,’ January 2020.
5 See Funds Europe, December 2019 Issue, ‘Active versus passive: enemies or brothers?’