ETFs and index funds generally take less fees than actively managed funds. This is explained by the workd "active". The active funds are managed actively and their aim is to beat the index. ETFs and index funds are just trying to passively mimic the return of the given index like S&P500 for instance. Passive management enables these funds to run on low costs which of course attract more investors.
The competition comes more fierce then when asset managers are offering these kinds of services with zero-cost. The Nordic people might already be familiar with Nordnet´s "Superfunds" which are offered to investors with zero cost. Couple weeks ago also Fidelity shocked the investment world by starting to offer zero-cost index funds with an international horizon. The international Superfund immediately became a hit.
The figure below shows the investment flows to passive index funds vs. actively managed funds. The costs really matters. Investors are moving their money where the costs are the most efficient or non-existent. Cost are relevant since the longer the investment period, more the annual costs start dragging your return lower.
So the million dollar question for banks and asset managers is: Are active mutual funds anymore necessary? What is the reason and the incentive to offer relatively costly active mutual funds for investors in the long-run?
Couple of issues exists with the future of actively managed funds. First of all is their whole justification. A study conducted in Berkley University in 2012, found out that nearly 74 % of all the active funds underperformed their index. Now when the whole purpose of active management is to BEAT the index, it might be fair to say that many active funds fail in their mission. Added the fact that investors are paying the high management fees to portfolio managers who are almost doomed to fail in their management, the whole purpose and marketing of the active funds seems a bit fishy for the experienced investors.
The second issue is the information that is available and the regulation. Currently investors can find so much information and statistics helped partly by regulation MiFID II) concerning different investment funds that the returns and the costs are transparent and all the funds from different managers are comparable with each other in terms of return and cost. Enlightened investors know the fact that index funds are more probable to offer higher return than actively managed funds, with lower management fees and thus are moving their money from active funds to passive ones.
How long active funds can keep on going before they run out? Most of the banks are already selling their funds with a loss to attract investors. Cheap index funds are of course a strategy to lure investors to the firm and get the profit from other services such as stock or derivative trading fees. This is for instance how Nordnet and Fidelity work with their offering of zero-cost funds.
I wrote a blog on AI-based portfolio management last year and I want to remind this again. If active fund management dies and the passive index funds are managed by AI, as a graduate CFA in portfolio management I´d be quite worried about the future of the profession.
My theory is that eventually active index funds must come up with some new lure to attract investors or they will die out in the competition against passive fund management. Their purpose and existence isn´t anymore justifiable.
Asset managers are already facing the competition with zero-cost index funds and this might become the new norm. Other managers must react to this fast if they want to keep in the competition. Those who can offer the most cost-efficient products with the best return are the winners.
If they still manage to stay in business with their zero-cost index funds.
Text: SW
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