Active Management Can’t Catch A Break

Written by John Osbon on June 21, 2016

“Passive funds grow 230% to $6tn”. Attracta Mooney wrote that headline in the usual spare Financial Times fashion. This is just one more data point in the dramatic flow of assets from actively managed portfolios to index, aka passive, investment strategies. This seems to be happening even more quickly than the industry expected. Why? And what does it mean for you?

Larry Fink says it, too

Bloomberg quotes Larry Fink, head of Blackrock, the $4.6 trillion asset management company: “There will be a massive shift into passive investing amid consolidation in the asset management industry. Active fund managers are struggling to beat benchmarks.” According to FT active management comprises $24 trillion and passive is $6 trillion. But passive is growing four times faster. The active lead is shrinking quickly.
Economists often debate whether markets are rational. To me, this shift to index-based investing is a certain sign that the financial services market is getting more rational all the time. Indexing means more for you and a lot less for 20th Century sales machines peddling investments you don’t need. Active management is declining due to high costs and high taxes that subtract value compared to passive index funds. The switchover is accelerating and the investor benefit grows.

Why?

Studies have shown that the high fees inherent in active management (the cost of economists, researchers, strategists, plus trading costs) make beating a benchmark the exception to the rule. Lower the fees to 5 basis points (from 120 basis points, the active standard) and the performance gap virtually disappears. Add in the tax efficiency of passive investing – virtually no capital gains distributions for most index ETFs – and the individual investor is way ahead. The public is catching on to a good thing and voting with their hard earned investment dollars (following many institutional investors, by the way).

Proud to be passive

Osbon Capital was founded a dozen years after the first index ETF appeared. We were excited to get on the indexing train as it gained early momentum as a better way to build portfolios for individuals. Eleven years later the indexing trend has grown from upstart to juggernaut, with no reversal in sight. Passive Power, written in 2013, remains as timely as ever.
John Osbon – josbon@osboncapital.com

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