It has been a decade in the making, but it finally, unceremoniously, happened. The AUM in passive investment vehicles, like ETFs, has finally overtaken that in actively managed ones, like mutual funds. As of August 31, money in passive funds totaled $4.27 tn, just a touch higher than the $4.25 tn in actively-managed funds. In a good summary of the overall change in landscape, the Wall Street Journal says “That shift lowered the price of investing for individuals, reduced the influence of stock pickers and turned a handful of Wall Street outsiders into the biggest power brokers in the industry”.
FINSUM: Every advisor reading this column knows exactly why this happened, but it is nonetheless a landmark moment. It is also perhaps a warning sign—which side is driving the market?
Investors likely already know that low cost index funds tend to greatly outperform high fee actively managed funds (to the tune of 1.5% or more annually). That comes as no surprise. However, what was surprising to us is that in fixed income, the tables are greatly turned. While passive funds do have a slight edge over active ones on average (0.18% per year), in many cases high fee actively managed fixed income funds outperform passive ones. This holds true over long time periods, including ten-year horizons.
FINSUM: This is an interesting finding and one that makes intuitive sense. The bond market is vast, hard to access, and full of intricacies. That kind of environment lends itself to specialism in a way that large cap equities does not, and the performance metrics show it.
ETFs are a product that has been growing at breakneck speed. AUM in the product is approaching $4 tn, which is astonishing given that it has really only taken a decade to get there, but still quite a bit smaller than the $16 tn in mutual funds. Experts say that the ETF market is going to increasingly resemble the mutual fund market as offerings diversify into smart beta, thematic ETFs, customizable ETFs, and fixed income. The last area—fixed income—is where creative indexing makes the most sense, as doing so can account for the common weighting issues that are much riskier in bonds than in equities (you don’t want your largest holding to be the issuer with the most debt).
FINSUM: The logic for fixed income ETFs is very strong, especially given how illiquid and restrictive buying bonds directly is. However, smart beta and other active ETFs (which are more expensive) don’t really have a big leg up on experienced mutual funds.