By Arnaud Houdmont, Chief Communications Officer
“86% of investment managers stunk in 2014”
“Active Management Funds Underperform Over Almost All Time Frames”
“Epic Fail: Another Dismal Year for Active Management”
“Can anything save active management?”
These are just a few of the latest headlines confining the “active management” of investment fund portfolios to the dustbin of history. Following years of persistent failure by the majority of fund managers to outperform the market, the evidence in favour of index investing - also known as “passive” - is building up.
Active management investment companies believe it's possible to outperform the market and produce better returns than passively managed index funds. However, bar a few exceptions, actual results tend to demonstrate that with high fees, scarce talent and intense competition, it is virtually impossible for active managers as a whole to outperform indexing in the long-term.
Since there’s a lot more money to be made from active management than from indexing, advisors and managers continued to spin the truth for years. But with increasing evidence illustrating the actual performance of active management, fund managers had to turn to other tactics to justify the high fees.
Whereas some advisors did turn to indexing, they refused to relinquish their high fees and resorted to underhand practices such as “index hugging”, allowing them to limit the risk of underperformance by clinging to the index. Obviously these “closet index huggers” do not advertise the fact that, for all intents and purposes, they are charging “active management” fees for what is essentially passive management. The Nordic Supervisory Authorities, for instance, are now investigating these "closet indexing " practices.
“Smart Beta” to the rescue…
Smart, Strategic or Alternative Beta funds are essentially index funds with a twist in that, rather than relying on traditional market capitalization based indices, they use alternative weighting schemes based on measures such as volatility or dividends, amongst others.
There's nothing new about investing based on these different factors and some defend the practice by claiming that Smart Beta merely fills the gap between active and passive management. Others take less kindly to this new trend, which according to Bloomberg Intelligence now accounts for more than $400 billion - or 20 percent of all assets - in ETFs in the United States.
Zero Hedge labels the practice as “active management on autopilot”. Advocates of traditional indexing, such as Vanguard’s Jack Bogle, definitely don’t think highly of Smart Beta: “Smart Beta is stupid; there’s no such thing. It’s an idiotic phrase.”
With the jury still out, the question is whether Smart Beta can ever amount to more than a marketing ploy for the active manager turned closet index hugger?
Background Media Reading: