Above the benchmark:
How indexing has grown up

Vanguard Group founder John C. Bogle in 2014

Passive products are on track to break another benchmark record this year in a move that could see indexers take majority control of the US equities fund market.

According to a late 2018 Bloomberg report, data from research house Morningstar shows passive US share funds grew market share from 45.7 per cent in November 2017 to 48.1 per cent 12 months later.

“They’ll top 50 percent in 2019 if the current trend holds,” Bloomberg said at the time.

Unfortunately, Jack Bogle, the Vanguard founder, won’t be around to witness the historical moment as the niche passive fund concept he pioneered in the 1970s becomes the biggest game in town.

The indexing icon died this January leaving the company he created in charge of US$5.1 trillion invested on behalf of more than 20 million clients in 170 countries.

Bogle built Vanguard on the back of two fundamental beliefs: that most active fund managers can’t beat the average share market performance over the long-term; and, that investors need to access market returns through low-fee vehicles.

As he told Reuters in 2012: “Invest as efficiently as you can, using low-cost funds that can be bought and held for a lifetime. Don’t go chasing past performance, but buy broad stock index and bond index funds, with your bond percentage roughly equalling your age.”

But since Vanguard launched the world’s first index fund in 1975 much has changed in the passive investing universe.

For one, investors today have a much wider choice of indices to mirror beyond the “broad” share and bond benchmarks Bogle preferred: a 2018 study by the Index Industry Association (IIA) counted 3.288 million investment indices across its 14 members who collectively manage about 98 per cent of the world’s financial benchmarks.

And a second innovation in the 1990s – the exchange-traded fund (ETF) – has enabled product providers to more easily launch and distribute funds that track all manner of indices.

According to researcher ETFGI, as at the end of March this year there were 6,613 ETFs listed globally managing a collective US$5.26 trillion.

In some respects, the sheer scale of both index and ETF multiplication belies the passive origins of the investment vehicle: today, many ETFs feature ‘active’ selection rules (such as screening on environmental, social or governance – or ESG – criteria) or operate in complex asset classes, often using derivatives to gain exposure.

Even outright actively-managed ETFs are gaining ground, ETFGI reported in February this year. The researcher noted funds under management globally in active ETFs hit a historical high this year of US$112 billion.

ETFs might be the fastest-growing sector in the index investing world but the bog-standard passive managed fund structure beloved by Bogle still holds the most assets under management across the world.

Both the managed fund (unit trust) and ETF benchmark-tracking methods have their pros and cons, which a recent AMP Capital NZ note published on InvestNow explains clearly from a Kiwi investor perspective.

Mike Heath, InvestNow general manager, says index-investing in general has proven to be a popular choice on the platform across ETFs and managed funds.

“For example, the Vanguard international shares exclusion fund – which is an Australian unit trust – is the most-used product on InvestNow,” Heath says. “Over 25% of the InvestNow retail portfolios have invested in either the hedged or unhedged version of the Vanguard fund.”

“Of course, it helps that we offer the cheapest access point to the product for NZ retail investors but we’re also seeing growing interest in the two AMP Capital index funds on InvestNow – covering local and global equities.”

Unlike the Vanguard funds the AMP Capital products – that have similar rock-bottom pricing – are offered as portfolio investment entities (PIEs) with certain tax benefits for NZ investors.

InvestNow members are just as enthusiastic supporters of the Smartshares ETFs available on the platform, Heath says.

He says three Smartshares ETFs number among the top five most popular products currently on InvestNow. The platform recently added five new ETFs following feedback from members bringing the total Smartshares product range on InvestNow to 12.

Late in April Smartshares announced it would release a new suite of eight ETFs managed by the BlackRock-owned iShares in June. Most other Smartshares ETFs feature Vanguard as the underlying manager.

However, the majority of the new Smartshares ETFs – due to list on the NZX in June – cover more exotic ground than the existing batch: five of the iShares-backed funds are various global share sector funds tilted towards ESG factors; two others target ‘thematic’ investing trends – robotics/automation and healthcare; while the third is a simpler benchmark-tracking international bond fund.

“We’re certainly interested in offering the new Smartshares products if there is demand,” Heath says. “There is growing interest in ESG-investing, for example, and some InvestNow members might like to gain exposure via ETFs.”

If the InvestNow experience is any guide, the index-investing revolution set ablaze by Bogle more than 40 years ago is undoubtedly on fire in NZ too. (As an aside, the NZX was an early-adopter of the indexing trend, launching one of the world’s first ETFs in 1996.)

However, Heath says in spite of the burgeoning interest in passive funds, InvestNow is also seeing substantial support for active managers across all asset classes.

“It’s not really an either-or thing,”  he says. “Many InvestNow members are building diversified portfolios using both passive and active strategies.”

“The benchmark that we really care about is providing the best service in the market to self-directed Kiwi fund investors – whatever route they choose to travel.”