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Has active management grown too big?

The asset management industry is vast. With active and passive managers, individuals are constantly on the hunt for the best returns. Many would assume that the best returns come from the active managers as teams aim to beat the market. But some are now saying that the active industry has grown too large to consistently produce market-beating returns.

Active portfolio managers are struggling to consistently beat their benchmarks after fees are taken into consideration. Many investors are now turning their backs on traditional stockpicking funds in favour of passive options, such as exchange-traded funds (ETFs).

This move is changing the shape of the market. Last year ETFs attracted $2,871 billion in assets, by comparison, actively managed funds lost $124 billion.1 ETFs are even starting to overtake more ‘secure’ investment methods such as bond funds.

When mutual funds grow to a certain size the incentive shifts from attempting to ourperform the benchmark to not wanting to underperform. This makes the fees associated with these funds difficult to justify as an ETF will generally match its benchmark minus the tracking error (the cost).

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As the size of the actively managed funds have grown so have the number of employees. But since timing the market is a difficult skill, not dissimilar to gambling, the number of talented individuals able to do this has not increased. Many mutual funds charge much higher fees for performances similar to those achieved by ETFs.

The active industry needs to ensure that the availability of skill matches the size of the market they are able to cater to. Otherwise they are in the territory of over promising their customers.

Individuals need to be prudent when choosing their investment channel and ensure they take cost and anticipated performance in to consideration in tandem. The only thing you can completely control when investing is cost. If you are going to be paying more you need to ensure you are getting more for your money, otherwise wealth accumulation becomes that much more difficult.

1 ETFGI.com

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