Active managers survival guide in a passive management jungle

  Lire cet article en français

This is a very depressing time for active fund managers, as the attack of passive asset management is brutal, flanking them from both an aggressive media coverage and strong cash outflows. Who indeed could have predicted that John Bogle, yes John Bogle Vanguard’s founder, would become such a rock-star today! His pictures and quotes are just all over my tweeter feed. And it is not going away soon…

And cash inflows/outflows are just even more worrying for them. As more than 30% of US assets under management were passively managed at year end 2016, and a clear momentum for a continued increase in 2017 dawns, traditional asset managers can actually start to be scared, at least. With good reasons to !

However, the current never ending beating up of active management became that strong and mainstream, while the answer given by active managers that shaky, that we could rightfully wonder if this is not getting a bit too far. Well, of course I must confess that I am among the first ones to give them a friendly slug when I can, sorry about that, but I also consider that they might need a helping hand guiding them out of this. There are some limits to plain criticism and being more constructive is possible.

Yes, because I am convinced that active fund management is not “dead” as the ETFs extremists, Jack’s fanatics seem to believe. Well, there is of course hard work to be done, I cannot hide it. However their economic usefulness is certain, and their existence in the investment’s big world secured… if they do decide at last to engage in a deep and disrupting reform.

So here are the 7 structural changes I advise which could separate a “dead” asset manager from a living one in the hostile jungle of asset management of the upcoming years.

  1. Lower the fees ! A lot ! This is not going to cheer them up but there are no way out of this, and this the first and main survival rule. In fact this is such a “captain obvious” advice that I should not even talk about it. A European large cap equity fund manager who intends to survive with a TER (total expense ratio) above 1% is clearly delusional, and reality will catch up to him someday. Sadly this means that fund managers will have to waive goodbye to their excessive compensation packages and welcome more reasonable, and competitive, ones. But they should not get this wrong : this is not a choice, as market will force them a way or another into it, may it be through massive outflows, or even funds (and managers job) closures.

  2. Limit investment to a clear and stable horizon. In an environment where roboadvisors are growing, where strategic allocation made it back to its central role in financial advise, and finally where ETFs are disclosing crystal clear compositions, active funds must follow this lead. They should become independent blocks, pure players of their asset class, in order to ease their association in strategic allocation, robotized or not. Bottom up is not favored anymore in allocation, and funds are more and more chosen for their asset class(es) exposition(s) and a lot less for their hypothetical alpha. Variable allocation funds or “black boxes” are indeed going to be harder to sell from now on.

  3. “Benchmark” to an ETF. Having a clear investment horizon is good, but what would be even better would be to compare directly and fearlessly to one or several ETFs. This is a way to stand strong, to say in a credible tune “We are not scared”. An active fund which believes in its added value to investors should compare itself with its passive counterpart. By the way, it would be a way better benchmark as it is investable. They might of course risk to underperform their benchmark (well that would not be the first time, would it ?), but investors will compare them this way more and more frequently anyway. Moreover, they could profit and not endure the current movement towards ETFs, which is not only a flee to the lowest fees, but also a deeply rational simplification, focusing back on allocation.

  4. Make the active funds a lot more liquid. First of all it is more than time to get rid of subscription/redemption fees paying inducements. Those are backward relics and should be eliminated. Those fees, not null, and paid to the fund of course, should be representative and pay for the actual transactions costs needed to invest subscriptions (0.1%-0.2% for large cap. equity seems reasonable). Weekly or monthly nav computation should also be limited at best, as daily valuation is now standard. An even better alternative would simply be to choose an ETF-type “structure”. Those funds would become active, discretionary, non automatic (smart beta exists already no need to reinvent it) funds, but as an ETF, greatly improving their liquidity.

  5. Endorse a full transparency policy on investments. One of the major issue with active funds is that no one actually knows what is really inside. When an investor sees a line called “Our Wonderfully Great Global Allocation Fund” he cannot link it to any of the underlying investments. Fixed Income ? Equity ? Which one ? This is not only a strategic allocation issue, this is also an economic reality question. Investors need to be able to go freely through the fund layer to understand and modulate the real economic actors they finance, and measure more adequately their investment risks. Every fund manager should give access to the composition of his fund in real time, whether it is through its website, or even better through a dedicated API. Transparency, technology, roboadvisors will love them for it !

  6. Show some modesty regarding the potential alpha they might create. Active managers are way too confident when they describe their strategy and selection methods. How many times did I have to nod a fake approval in front of some fund manager explaining how different his management was, directly inspired from Warren Buffet’s methods, and selecting only the best of the best stock that could possibly exist… But this is not that easy, and this is starting to be well known. Recognizing and showing their investment limits, promoting a credible method based on economic facts, scientific analysis and evidence, and with measurable results, and not only on manager’s genius opinion or financial dogmas, here is what could restore some credibility to active management. The myth of the never failing star manager has vanished.

  7. Ensure a minimum tracking error. Oh yes, you read well. Minimum. If they want to differentiate themselves from passive funds, active managers while have to be… active ! No more closet indexers, please welcome real asset managers, who take real discretionary risks. Even if they are wrong. With comparable or slightly higher fees than passive funds, investors shall be able to choose funds with a real possibility to overperform. In fact even an underperformance is not that dramatic, as it still brings diversification to the portfolio, which will benefit the investors on the long run anyway (as long as fees are comparable of course).

Here is the way I wish active management will follow from now on. Less fees, more transparency, more liquidity, more stability, more diversification, more credibility to sum it up. This should allow active funds not only to survive this hostile environment, but actually to thrive on it, this by adapting completely and raising again as a serious competitor to the swarm of ETFs that simply follow a market-cap weighted index.

Because at the end, do we really all want to have market capitalization as our only investment parameter? Does that seem really reasonable to you? I don’t think so. I don’t for sure, and I want real active managers, modern, fee-modest, even if John Bogle dislike it. Let’s hope they listen to those pieces of advice.

Leave a Reply

Your email address will not be published. Required fields are marked *