Index ETFs Chip Away at Active Fund Industry
March 26th, 2013 at 1:00pm by Tom Lydon
Actively managed funds have been underperforming the broader markets and witnessed investor assets shift over to passive exchange traded funds. Now, large pension funds are beginning to make the move as well.
The California Public Employees’ Retirement System, which holds $255 billion in assets with over half already invested in passive strategies, is starting to review its active managers, InvestmentNews reports.
“It’s sort of an exclamation mark on a trend that most are aware of,” Chris McIsaac, managing director of the institutional investor group at Vanguard Group, said in the article.
Fidelity Investments has also been caught up in passive investments as the company partners with BlackRock to increase the number of commission-free iShares ETFs on its trading platform. [Fidelity, iShares Expand ETF Partnership: What Does it Mean?]
“We see don’t see it as either passive or active, we see it as both,” Scott Couto, president of Fidelity Financial Advisor Solutions. “In a low-return environment, fees matter a lot. That’s getting interest in passive investing over the short term.”
Beth Flynn, vice president and head of third-party ETF platform management at Schwab, which recently launched its commission-free OneSource ETF platform, also believes that fees will continue to have an effect on investment decisions. [Schwab Unveils Game-Changing Commission-Free ETF Platform]
“There will continue to be a growing interest in the passive side because cost matters to investors,” Flynn said in the article. “Virtually all our adviser clients use ETFs in some way, shape or form.”
U.S.-equity ETFs show an average expense ratio of 0.40%, whereas the average expense ratio on actively managed mutual funds is 1.34%. Two broad U.S. stock ETFs from Schwab come with expense ratios as low as 0.04% while the cheapest actively managed large-cap fund costs 0.50%. [Asset Flows Show Growing Interest for Low-Cost, Passive ETFs]
Moreover, the number of active managers who beat their benchmarks is declining. Over the past decade, only 38% of large-cap-equtiy managers beat the S&P 500; over the last five years, only 31% beat the index; and over the past three years, just 18% outperformed.
According to Lipper data, 86% of the $4.4 trillion in mutual funds and ETFs a decade ago were in active strategies. In comparison, the active management’s market share has diminished to 72% as of the end of last month as investors pulled $287 billion out of active funds since 2003 and funneled $1 trillion into passive investments. [ETF Managed Portfolios: Disruptive Innovation and Mutual Funds]
As investors jumped onto the current stock rally, passive funds attracted $65 billion over the first two months of the year, compared to the $40 billion in new inflows for active funds.
“Indexing has proven to be a very compelling investment strategy, especially for investors with an extended investment horizon,” McIsaac added.
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Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.