ANALYSIS: Time for active funds to adapt or die

The active funds industry must shrink, cut prices, better-align itself with investors and differentiate if it wants to compete against a passive onslaught, according to a report by Morningstar.

ANALYSIS: Time for active funds to adapt or die

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While admitting it is a far from perfect guide, Becket points to the performance of the UK All Companies sector to the end of June, in which 191 out of 264 funds have beaten the FTSE All-Share

“At Psigma we believe that the asset management industry is going to go through huge change and the penchant for passive investing, in a world of lower returns and reduced profit margins, will stay strong,” says Becket.

“We see this as a mistake and believe that indices, and by extension passive funds, could well labour in the years ahead due to high valuations and a reduction in liquidity due to aforementioned factors.”

More differentiation

One finding from the Morningstar report is that with nearly 2,100 unique active funds in the US, more than half of which were large caps, funds need to do more to differentiate themselves from their peers.

“Do we really need this many active US stock funds?” asks Ptak. “The answer, of course, is no. And that can probably be applied to the broader active-fund complex, which seems overgrown and commoditised.”

The same accusation has been thrown at UK funds, with the question of the so-called benchmark hugging funds being called into question by the FCA paper.

“Our view has always been that investors should mix passive and active equity exposure, but rotate the allocation to each depending on your outlook,” says Becket.

“This is becoming an increasingly common view, and it would appear likely that many multi-asset portfolios will be built with a passive equity core and a smaller number of highly active funds to create specific biases.

“Indeed, the future for index plus a little type strategies with low tracking errors is likely to be poor, as investors shun the relatively high fees (over passive) and a lack of a story for end investors. In fact, I would go as far as to suggest there is no real future for such strategies.”

Passive domination

While the UK is some way behind the US in terms of the use of passive funds, Architas investment director Adrian Lowcock says the rise is gaining momentum and that it may get to the point where passives dominate the market.

“The active management industry does need to change to improve its image and has yet to find the right way to respond to the rise of passives,” he says. “There are too many funds, but also a lot of money chasing too few funds in the UK. This concentration into a few core funds will make them cumbersome and harder to manage, resulting in weaker performance over the longer term.”

While Lowcock says he wouldn’t want to see a world where new talent is excluded by barriers to active management, he agrees that charging structures need to change to refocus on the investor and reward genuinely good active managers. 

“At the same time the industry and investors have all been caught up in the short-term gratification issue which pervades much of society today (as it probably always has). Active management should really be reviewed longer term, 10 years plus, and then you can find the true value.”

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