The Active/Passive Divide – On The Other Side

Article written by InvestNow

Jack Bogle, the founder of passive investment pioneer Vanguard, never got to see the moment his whacky idea formally achieved market dominance – but he was this close.

Bogle died in January 2019 just three months before research house Morningstar clocked US passive share fund assets hitting par with actively-managed counterparts for the first time. At the end of April last year “both passive and active U.S. equity funds had a total of about $4.3 trillion in assets, essentially reaching asset parity”, Morningstar says.

“The forces that have driven this trend show no sign of abating,” the researcher says. “Now, the question is the degree to which active management will remain the preferred destination for investors in other asset classes, such as international equities and taxable-bond funds.”

Passive investing may be in the ascendance but it’s been a long journey to the top. After Bogle launched the world’s first true passive fund in 1976 (tracking the US 500 share index), the concept remained a cult secret for decades.

“At the end of 1998, there were 6.5 times as many assets in actively managed U.S. stock funds as there were in index funds,” Morningstar says.

Indeed, the index movement only picked up pace post the 2007/8 global financial crisis (GFC) as disillusioned investors sought cheap exposure to markets above expensive alleged stock-picking skills.

Local investors stir life into passive

NZ was slower to join the passive party than other jurisdictions but it has been catching up of late. Over the last couple of years, the rise of index investing KiwiSaver funds (as well as hefty passive allocations among many mainstream providers) and the burgeoning local exchange-traded fund (ETF) market suggests NZ is now well on-trend.

The growing popularity of passive investments also pops up in InvestNow investor data, that shows nine of the10  most popular funds on the platform are index-based. About a third of all InvestNow members have exposure to the Vanguard International Shares Index fund – the number one choice – while almost 25 per cent have bought the second-favourite Smartshares NZ Top 50 ETF.

Furthermore, InvestNow analysis reveals investors appear to be accessing index funds as more buy-and-hold assets compared to active products. Over the six months to the end of April, buy orders for active funds on InvestNow were more than double that of index products; similarly, active sell orders stayed about 50 per cent above that of passive during the period.

Still breathing: why active is not dead

For all the reports of its death, active management remains very much alive. In the NZ equities sector, for example, active managers have historically achieved benchmark outperformance after fees, on average over the long term.

And the active proponents scored a small rhetorical win earlier this year in a debate hosted by the Financial Markets Authority (FMA). The active team – chaired by Mint Asset Management chief executive, Rebecca Thomas – out-argued the passive opposition, which included Smartshares head, Hugh Stevens.

Thomas et al put it that passive management is counter to fiduciary duty, impedes true sustainable investing and could permanently damage investor wealth during a serious market downturn.

In a separate article, Thomas says: “Indiscriminate buyers and sellers like passive funds were inevitably caught in the ebb-and-flow of market panic [this March] with no capacity to adjust portfolios in line with the major changes COVID-19 measures have wrought on the NZ economy and markets.”

Stevens, however, told the FMA debate audience that the data has consistently shown passive investing outperforms after fees.

“The problem is the evidence, the problem is the numbers… Simply put, active management is a zero-sum game,” he said. “You have the winners [passive investors] and the losers [active investors]. In every active trade, someone beats the market and someone loses and underperforms the market. And then you add the fees.”

Checking the performance pulse

Both Stevens and Thomas can lay claim to performance data that backs up their respective arguments. Smartshares products, for example, top the InvestNow return charts for all periods up to three years to the end of this March: although, the winning funds generally hailed from different asset classes each time.

But the five- and 10-year charts feature a group of NZ active share managers, including Mint, in the top rankings. The Mint Australasian equity fund provided the best 10-year returns among those on the InvestNow list, outperforming its index alternative by almost 3 per cent per annum.

As usual, there are some caveats to interpreting such data including the important waiver that ‘past returns are not indicative of future performance’. And while InvestNow has a wide range of funds and asset classes on offer, it does not represent the full investment universe for the purposes of return analysis.

The tussle between passive and active investment styles is unlikely to end any time soon despite the fact both influence each other. Active management fees have certainly come down as low-cost index funds carve out market share. Conversely, the passive fund industry is increasingly offering active management opportunities to investors with a growing, and bewildering, range of bespoke index products.

Bogle is really missing something.

References:

The Active/Passive Divide – On The Other Side

Article written by InvestNow

Jack Bogle, the founder of passive investment pioneer Vanguard, never got to see the moment his whacky idea formally achieved market dominance – but he was this close.

Bogle died in January 2019 just three months before research house Morningstar clocked US passive share fund assets hitting par with actively-managed counterparts for the first time. At the end of April last year “both passive and active U.S. equity funds had a total of about $4.3 trillion in assets, essentially reaching asset parity”, Morningstar says.

“The forces that have driven this trend show no sign of abating,” the researcher says. “Now, the question is the degree to which active management will remain the preferred destination for investors in other asset classes, such as international equities and taxable-bond funds.”

Passive investing may be in the ascendance but it’s been a long journey to the top. After Bogle launched the world’s first true passive fund in 1976 (tracking the US 500 share index), the concept remained a cult secret for decades.

“At the end of 1998, there were 6.5 times as many assets in actively managed U.S. stock funds as there were in index funds,” Morningstar says.

Indeed, the index movement only picked up pace post the 2007/8 global financial crisis (GFC) as disillusioned investors sought cheap exposure to markets above expensive alleged stock-picking skills.

Local investors stir life into passive

NZ was slower to join the passive party than other jurisdictions but it has been catching up of late. Over the last couple of years, the rise of index investing KiwiSaver funds (as well as hefty passive allocations among many mainstream providers) and the burgeoning local exchange-traded fund (ETF) market suggests NZ is now well on-trend.

The growing popularity of passive investments also pops up in InvestNow investor data, that shows nine of the10  most popular funds on the platform are index-based. About a third of all InvestNow members have exposure to the Vanguard International Shares Index fund – the number one choice – while almost 25 per cent have bought the second-favourite Smartshares NZ Top 50 ETF.

Furthermore, InvestNow analysis reveals investors appear to be accessing index funds as more buy-and-hold assets compared to active products. Over the six months to the end of April, buy orders for active funds on InvestNow were more than double that of index products; similarly, active sell orders stayed about 50 per cent above that of passive during the period.

Still breathing: why active is not dead

For all the reports of its death, active management remains very much alive. In the NZ equities sector, for example, active managers have historically achieved benchmark outperformance after fees, on average over the long term.

And the active proponents scored a small rhetorical win earlier this year in a debate hosted by the Financial Markets Authority (FMA). The active team – chaired by Mint Asset Management chief executive, Rebecca Thomas – out-argued the passive opposition, which included Smartshares head, Hugh Stevens.

Thomas et al put it that passive management is counter to fiduciary duty, impedes true sustainable investing and could permanently damage investor wealth during a serious market downturn.

In a separate article, Thomas says: “Indiscriminate buyers and sellers like passive funds were inevitably caught in the ebb-and-flow of market panic [this March] with no capacity to adjust portfolios in line with the major changes COVID-19 measures have wrought on the NZ economy and markets.”

Stevens, however, told the FMA debate audience that the data has consistently shown passive investing outperforms after fees.

“The problem is the evidence, the problem is the numbers… Simply put, active management is a zero-sum game,” he said. “You have the winners [passive investors] and the losers [active investors]. In every active trade, someone beats the market and someone loses and underperforms the market. And then you add the fees.”

Checking the performance pulse

Both Stevens and Thomas can lay claim to performance data that backs up their respective arguments. Smartshares products, for example, top the InvestNow return charts for all periods up to three years to the end of this March: although, the winning funds generally hailed from different asset classes each time.

But the five- and 10-year charts feature a group of NZ active share managers, including Mint, in the top rankings. The Mint Australasian equity fund provided the best 10-year returns among those on the InvestNow list, outperforming its index alternative by almost 3 per cent per annum.

As usual, there are some caveats to interpreting such data including the important waiver that ‘past returns are not indicative of future performance’. And while InvestNow has a wide range of funds and asset classes on offer, it does not represent the full investment universe for the purposes of return analysis.

The tussle between passive and active investment styles is unlikely to end any time soon despite the fact both influence each other. Active management fees have certainly come down as low-cost index funds carve out market share. Conversely, the passive fund industry is increasingly offering active management opportunities to investors with a growing, and bewildering, range of bespoke index products.

Bogle is really missing something.

References:

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