Recent fund launches and acquisitions show that active mutual fund and exchange-traded fund managers are holding out hope that the ETF marketplace, in particular, and the asset management industry, in general, still have a place for them. But perhaps they are taking the wrong signal from the passive trend.
Mature market dynamics on the passive side have made competition fierce. Vanguard Group, BlackRock (BLK) Inc. (BLK) and State Street Global Advisors control nearly 78% of the assets. Over the past five years, the 20 largest passive (and quantitative) fund managers added $2.2 trillion for a total of $6.2 trillion, according to Morningstar Direct — and half that $2.2 trillion has gone into ETFs.
One side-effect of these flows: passive funds are getting cheaper faster, making it even harder for active managers to compete.
From 2010 to 2015, the asset-weighted average advisory plus administrative fee for active funds dropped 2 basis points to 54 basis points, while passive funds fell 4 basis points to 16 basis points, according to Strategic Insight data cited by McKinsey & Co.
"Much of index fund outperformance can be attributed to the cost differential," said Vanguard Chief Executive William McNabb at last year's Evidence Based Investing Conference in New York. "One third of the assets we manage are in active mandates, but we're low-cost first."
The 20 largest active fund managers have seen $360 billion in outflows against $6.8 trillion in assets through Aug. 31, with $236 billion in outflows from Pacific Investment Management Co., according to Morningstar Direct. And it takes the top 10 active managers to achieve the market share of passive's top three.
Active managers are facing "an existential crisis," wrote McKinsey in the report, "Thriving in a New Abnormal."
According to S&P Dow Jones Indices, 84% of domestic equity funds underperformed their benchmark indexes over the five-year period ended June 30. Global, international and emerging market equity funds had a slightly better record at 80%, 72%, and 75% underperformance respectively.
"A large pool of benchmark-hugging active assets — up to $8 trillion — will be up for grabs over the next several years as clients re-examine their core investment beliefs and manager relationships," wrote McKinsey. This will, in turn, compel innovation on active managers to rethink and restructure their process and offerings.
"In the traditional investment management world, everybody made money," said John Rekenthaler, vice president of research at Morningstar Inc. in Chicago. "There was no pressure to consolidate. Why compete? It was very diffuse and profitable. "Investors tended to think that what they were buying was unique and not regarded as commodity. Over the last 10 years, scale has developed and the businesses has commoditized."
Traditionally active managers are giving the passive and low-cost model a try with ETFs and are having some degree of success attracting investors. Fidelity Investments, which manages $311 billion in passive funds alongside $993 billion in active funds, has waded mostly into sector ETFs with $7.5 billion in assets. Goldman Sachs & Co. LLC jumped into ETFs with dampened expense ratios to attract $4.7 billion in little over two years in the market.
Other active fund managers haven't been sitting still, but many are sticking to their roots and waiting to see if a more permissive ETF structure — one with limited disclosure on the full portfolio — can get to market.
American Funds, T. Rowe Price Inc. and State Street Global Advisors are among those with regulatory filings looking to squeeze limited disclosure active management into ETFs.
Vanguard, on the other hand, is looking to issue daily-disclosed active ETFs. Though not confirmed, most in the market expects Vanguard to launch quantitative factor ETFs similar to those offered by Vanguard in Canada and the U.K.
The profound effects of the increase in assets being managed under fee-based advisers is also compromising the active fund market, said Hossein Kazemi, professor at the University of Massachusetts and senior adviser to the Chartered Alternative Investment Analyst Association. " Morgan Stanley (MS), Merrill Lynch and Wells Fargo, for example, receive around $60 billion in fund flows each quarter. The sheer volume does not allow for active management."
Some more traditional active managers — Columbia Threadneedle Investments, OppenheimerFunds Inc., New York Life Insurance Co. and Legg Mason (LM) Inc. (LM) — have grabbed a toe-hold in offering ETFs by acquiring managers that design and manage portfolios primarily using ETFs for asset allocation and strategic/tactical investment. Others, like Franklin Templeton (BEN) Investments (BEN), Principal Financial Group and J.P. Morgan Investment Management, have slowly layered in to ETFs.