Despite the migration of investors to passive investment strategies, there is a rosy future for active management, even though there will be winners and losers in the years ahead, according to a new report from Greenwich Associates LLC.
Although the Greenwich report published on Thursday concedes that the shift to passive strategies appears to be secular rather than cyclical, it maintains that there is a future for active managers.
There are several trends driving the shift to passive strategies, the report says, although it indicates that, “the primary driver has been the inability of active managers as a group to consistently outperform their benchmarks net of fees.”
Indeed, both institutional and retail investors are increasingly focused on fees, the report says: “There are clear signs that the new focus on fee minimization will become a permanent feature of the market. As evidence, the pooling of public pension funds around the world is seen as an important means of reform. In the U.K., Canada, and now in U.S. states like Indiana, plan sponsors see pooling as a way to generate enough scale to force down management fees and lower overall costs.”
On the retail side, policymakers are driving greater focus on the costs of investing, the report notes. “The oversight spotlight has landed on financial advisors in the form of the [U.S.] Department of Labor’s fiduciary standards rule, which is likely to boost investments in passive strategies by making advisors less willing to recommend active managers that could, in retrospect, be deemed not to be in clients’ best interests.
“Make no mistake; the growing institutional appetite for passive strategies is not just a cyclical phenomenon. It is a secular trend that represents a real threat to the business prospects of many active managers,” the report warns. “The number of investment categories capable of supporting robust active management franchises will shrink as large-cap global equities, certain corners of the fixed-income market and other areas become increasingly liquid and transparent.”
Yet, at the same time, the report says there will continue to be a role for active management in the years ahead. Indeed, it says active management “will remain a viable and attractive business due to a combination of continued growth in the institutional asset pool, innovation on the part of active managers and margins that, although narrower than they were a decade ago, remain robust relative to those found in other industries.”
“The overall institutional asset pool in both the U.S. and around the world is growing, and investors continue to need exposure to complex, opaque and illiquid markets not conducive to passive strategies,” says Andrew McCollum, managing director with Greenwich Associates, in a statement. “Those trends — along with innovation in active products and distribution models, and profit margins that remain quite attractive — will more than sustain active management.”
Yet, Greenwich does not see these trends supporting all firms. Rather, there will be winners and losers in this new environment, the report states: “The shift in institutional preferences represents a real threat to the business prospects of some active managers.”
The likely losers will be firms that “stick to traditional, product-centric approaches,” the report says. “This applies in a growing number of increasingly liquid asset classes perceived by institutional investors as offering diminished opportunity for alpha generation.”
“Active managers that fail to develop and communicate differentiated capabilities or introduce innovative new products in adjacent areas will see their franchises decline,” McCollum adds.
The firms that thrive in the future, the Greenwich report suggests, will be managers who specialize in complex asset classes for which they can either provide unique insight, or can exploit an informational advantage, as well as firms that add value to clients in cost-efficient ways.
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