The most consequential developments of the past 50 years? "It's a tie between the substantial gain in market share of low-cost passive investment funds and ETFs," and the incredible growth of private markets, said Lamar Taylor, interim executive director and CIO of the $185.7 billion Florida State Board of Administration, Tallahassee.
For veterans who cut their money management teeth in the late 1960s, it's no contest.
"The biggest single shift … was indexing," said Jeremy Grantham, who co-founded value equity quant shop Grantham, Mayo, Van Otterloo in 1977, following eight years at Batterymarch Financial Management.
"Index funds have been hugely important," especially if one looks at exchange-traded funds as simply an index fund wrapper, agreed Roger Urwin, co-founder of the Willis Towers Watson-affiliated Thinking Ahead Institute.
Grantham said Batterymarch began work on one of the industry's first index funds in 1971 — even though, in contrast to today, market inefficiencies then left ample room for alpha. Batterymarch's active small-cap value equity strategy beat its benchmark by an average of 6 percentage points a year over eight years, he noted.
The "zero-sum" argument — that combined returns of all active investors have to sum to the broader market's return minus trading and management costs — "has always been enough for big pensions to justify indexing," he said.
An ever-increasing number of institutional investors have done so in recent decades, bringing the indexed portion of institutional equity allocations to between a third and half of the market now, with further gains likely.
"I expect to see indexing continue to grow … because it's very hard to beat," said Robert Arnott, chairman and founder of Research Affiliates. But that could raise questions as indexes "don't care about price discovery (or) productivity enhancements from entrepreneurial capitalism," arguably working more to the benefit of "zombie companies" than new, disruptive competitors, he noted.
Over a 46-year career, Arnott has continued to explore the intellectual foundations required to build a better indexing mousetrap, such as his fundamental indexing approach, by which the size of a company's underlying business, rather than its volatile market capitalization, determines its index weighting. At present, Arnott said, he's examining the argument that the roughly 30% valuation premium constituent companies in the S&P 500 or the Russell 1000 enjoy make it advisable for active managers pursuing long-term gain to focus on companies that aren't index constituents.
Longer term, even if indexing continues to steamroll ahead, gobbling up 75% to 80% of the market, Arnott predicted the ability of markets to effectively set prices will prove resilient. At that level, "you'll still have price discovery, you'll still have allocation of capital to new ideas, good ideas, and you'll still have the opportunity for public companies that are not yet in an index to outperform those that are in an index," he said.
Others are more cautious.
"I think the notion that everyone can be a free rider and this system will function how it needs to, both from a market and from a governance perspective, will be challenged over the course of the coming 30 years," predicted George H. Walker, chairman and CEO of Neuberger Berman.
"There's a kind of creative tension here," raising questions about whether the market could be approaching the point where indexation creates anomalies and maybe opportunities for active managers, said Jim McCaughan, who joined strategy consultant Indefi as U.S. practice leader this year after leading Principal Global Investors for more than 16 years through 2018.
By contrast, Charley Ellis, the founder of asset management strategic consulting firm Greenwich Associates — now Greenwich Coalition — who has argued for decades that the ever-increasing efficiency of U.S. markets makes active investing a "loser's game," said he doesn't see that point looming on the horizon.
"We've got an extraordinarily gifted, talented, highly committed, wonderfully well endowed, really expert group of people working in active investment management. Only problem is, so is everybody else who's actively involved in investing … They've got terrific technology, terrific information and the government is saying there's some rules that we think you got to play by — all of which did not apply in the '60s, when active investing was a winners' game," Ellis said.
"When there's a substantial number, like 50% of the people who are now involved in active investing saying … 'screw it. I want to be a dentist instead … or I think I'll go sell shoes somewhere,'" then maybe active investors will be able to breathe a little easier, Ellis said.
Barring that, the space left for active managers to successfully flex their stock-picking muscles will continue to narrow, he predicted.
That backdrop should leave active managers under pressure as the bulk of net new allocations continues to go to index strategies and ETFs, at one end of a barbell strategy, and growing private markets allocations on the other, analysts said.
Those growing private markets allocations reflect "a remarkable change in the way in which our businesses are financed," with the issuance of public equity or bonds or bank lending having given way to, first, private equity, and increasingly since the global financial crisis, private debt — resulting in more robust portfolios for institutional investors, said David A. Hunt, president and CEO of PGIM.
That trend has prompted asset managers over the past decade to either acquire private markets capabilities or strengthen existing capabilities.
Steve Peacher, president of SLC Management, said parent company Sun Life of Canada tasked him in 2013 with developing an asset management firm that would build on the insurance company's fixed-income capabilities by adding yield-oriented alternatives as well, with the aim of offering that expanded suite of strategies to institutional clients. Over the past decade, SLC Management acquired real estate, infrastructure and private credit affiliates, as well as an independent wholesaling platform to market those capabilities to high-net-worth investors, he noted.