The rise of index funds and, more recently, private markets investments have been key disrupters in the story of U.S. retirement savings that Pensions & Investments has been covering over the past 50 years.
The ripple effects — which have thoroughly reordered a world of 60% stock, 40% bond pension portfolios run by bank trust departments — continue to be felt, even as newer influences, such as technology and artificial intelligence, appear poised to power the next wave of change.
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.
Money managers and analysts say continued gains for indexing and private markets should leave managers of long-only, active stock and bond strategies facing considerable headwinds.
Active long-only managers have been struggling for years but a 40-year bull market for bonds and a 20-year bull market for stocks effectively muddied the waters for clients who haven't been particularly discerning in separating alpha from beta, noted Donald Putnam, managing partner of investment banking boutique Grail Partners.
With the end now of that beta bull run, long-only managers are in danger of being eviscerated, and they will find it ever harder to compete in the crucial hunt for talent, Putnam predicted. "If you were (an extremely talented portfolio manager today) you wouldn't be running money for 30 basis points, talking to committees of the union of machinists … you'd go off to private equity or to hedge funds," he said.
Active long-only managers, while conceding that industry headwinds look set to grow stronger, say consistent outperformance across investment cycles should allow them to sustain their businesses going forward.
William Blair's focused strategy for U.S. large-cap growth equities, which has continued to outperform its benchmark over long time periods in one of the most efficient markets in the world, is enjoying its best flows ever this year, noted Stephanie Braming, the firm's global head of investment management.
A William Blair spokesman said the firm has seen net inflows of more than $4 billion for its U.S. large-cap growth equity strategy over the 10 quarters through June 30, accounting for more than half of the strategy's AUM of $6.8 billion.
Meanwhile, managers say they're investing heavily in technology and artificial intelligence, which are promising to open the door for a level of customization for mass affluent investors they previously could only afford to offer to investors with multimillion-dollar portfolios.
Likewise, new technologies allowing for the tokenization or securitization of private markets investments look set to allow retail investors to narrow the gap with institutional investors in terms of the range of asset segments they can invest in.
Bruce Cameron, partner and CEO of Berkshire Global Advisors, an investment bank focused on the asset management industry. So even if "I can't go out and buy a building … I'll be able to get participations in real estate or private equity or infrastructure," he said.
There's a "convergence of public and private markets," said George Gatch, the CEO of J.P. Morgan Asset Management. Going forward, "there won't be alternatives and not alternatives. There will be liquid traded, securitized, tokenized access to every asset class in the world, and maybe ones that aren't on this world," he said.
"The individual has become the dominant part of the asset management industry … and the wealth management industry will continue to be the dominant area of growth," Gatch said.
Technology, meanwhile, looks set to change the way the individual will manage his or her finances, analysts said.
On the individual side, most people on the planet will have "a comprehensive relationship with a financial services provider where they and their AI know more about us than we know about ourselves," predicted Rich Nuzum, executive director, investments and global chief investment strategist with Mercer.
That will involve allowing that provider to "Big Brother us," Nuzum said. "We will have turned on our Fitbit. We will have turned on our GPS and our phone in the car so they can monitor how we sleep, how we drive, what our diet is, are we exercising and use that to calibrate our insurance coverages."
And "when we have a life event, birth of a child, child goes to school, get a bonus from your employer, get a new job, whatever, they'll know about that" and prompt us along the way with smart default options, he said.
If market veterans are enthusiastic about the possibilities for managing money over the coming decade or two, they are decidedly glummer about defined contribution plans' continued rise at the expense of defined benefit plans.
Stephen McCourt, managing principal and co-CEO of investment consulting firm Meketa Investment Group, asked what he considered the most important development in retirement savings over the past half century, said "sadly, the decline of defined benefit funds, and the rise of 401(k) plans in their place."
Charles Van Vleet, assistant treasurer and CIO of pension investments at Textron Inc., struck a similar tone, saying "the most consequential development (not in a good way) has been moving investment management decisions to DC participants — away from professional DB investment teams."
Market veterans pointed to the huge gaps in coverage for workers without access to an employer-sponsored plan in the U.S. as an issue that should have been addressed over the past half century and must be addressed expeditiously over the coming 50 years.
"Roughly half of our workforce gets a private benefit," noted former Greenwich founder Ellis. "The others depend on Social Security, period. That's a real stunner and as a society we're making a big mistake," he said.
"Some people say it's not the government's job. I kind of think it is but as a society we're not doing something we know damn well we ought to be doing," Ellis said.
