While the investment world is unlikely to see a general retreat from what is called the "passive" approach that caught on in the post-GFC bull market, the case for more "active" approaches appears to be making a bit of a comeback.
Trawling through my email inbox gives me a feel for the ebb and
flow of certain topics. Right now, artificial intelligence
is all the rage. A few months ago, it was the Metaverse, and
before that, digital assets and cryptos. ESG investing surged,
and then went quieter last year when the realities of energy
intruded. A decade ago (yes, it was that long ago), robo-advisors
were going to eat wealth managers’ lunches (and probably their
suppers as well). Some of these ideas have played out,
Slightly less noisily, I’ve noticed a trend of fund managers focusing more on active management again. (See an article here from a few years back on the pros and cons.) I don’t hear as much about the merits of “passive” investing these days. Of course, the term “passive” isn’t very insightful because even taking a decision to put money into a bog-standard ETF to track the S&P 500, for example, is an active decision. But even so, recall what it was like a few years ago during that long bull run in stocks that was driven in large part by very low interest rates. Passive funds were the hot thing. Chasing after “Alpha,” unless you happened to play in illiquid, obscure areas, was regarded as futile and a waste of money. The flood of money into exchange traded funds was proof of the trend. At the end of February, $9.6 trillion of assets were invested into ETFs, according to research firm ETFGI. A prodigious sum.
The shift to passive funds over the past two decades has had several effects. The rise of fee-based financial advice and the squeezing out of trail commissions in countries such as the UK after the 2013 Retail Distribution Review (a decade old!) meant that advisors were keener on value for money. If they could construct a portfolio using cheap ETFs for most of the building blocks, that was all to the good. The “active” stuff would be icing on the cake, not the main deal. And so it has largely played out. Of course, this being an inventive industry, we have had the arrival of “smart Beta” funds, or “factor-based investing,” where sources of return are unpacked and can then be tracked by ETFs and other entities. Also, the asset allocation process, which drives the bulk of the variation of returns, can be done by using passive funds. This applies both on the strategic and more tactical side.
But…the last few years give me the impression that while the “passive revolution” hasn’t reversed, it hasn’t quite the dominance it might have had. For a start, the sort of bond/equity market rout of 2022, when 60/40 portfolios both fell as interest rates rose, has focused minds. More tactical asset allocation looks more attractive. A period of perhaps more muted stock and bond market returns in many countries puts more focus back on securities selection. Chatting to a large fund management house this week, that’s definitely the thinking out there.
None of this means that the insights passed on by the likes of the late John Bogle, founder of Vanguard, have ceased to hold force. For many, trying to beat a market index is a mug’s game, and it is very hard to do this repeatedly. When I started out as a financial journalist in the 90s, there was this “cult” of the “star manager.” I can recall, to take a UK example, how Anthony Bolton of Fidelity was feted for his ability to keep beating the market year after year – until he didn’t. Bookshelves in the business sections would be crammed with tips from clever investment figures. And of course, everyone wanted to be Warren Buffett.
It’s inevitable that there was pushback against some of this, and rightly so. The wealth management industry has, I hope, reached a rather more mature conversation where the “active” bit of the job is still about decisions about risk, the goals of a client, the need to adjust allocations in light of major trends, and to stay nimble where necessary. The tools in the box to put ideas to work may now be cheaper – and that’s a good thing. Another point is that active management is also about putting shareholders in the decision-making driving seat over the companies they hold. An issue in today’s financial world is that the rise of passive investing puts a big distance between the beneficial owners of a company and the men and women on the board. For all the talk about ESG, I don’t see enough focus on how to fix this challenge.
Long gone are the days when Mr and Mrs Smith kept a share
certificate on their mantlepiece or in a desk drawer and then
they’d make a note of turning up to a meeting. Nowadays, almost
all of this level of engagement is delegated away. Even among
those of us who have portfolios and remember to go online and
check them, how many of us remember our top holdings or closely
follow what the firms are up to? This is all a part of what
“active” management means.
The past few years have seen a major shift in the way that people own capital, and the extraordinary period of very cheap borrowing and quantitative easing that has created a set of distortions that will take years to unwind. And the very structure and technology of the market has also changed what “popular capitalism” means. At this juncture, the idea of “passive” investing does appear to have reached a peak. That’s not a bad thing.