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19 Nov 2018

 

Passive or indexed investments provide low cost access to a very wide range of markets, and there’s next to no risk of them significantly underperforming the indices they track. So does that mean active managers’ days are numbered? We commissioned a research paper from the Lyxor Dauphine Research Academy – a partnership between Lyxor and Paris-Dauphine University’s renowned House of Finance – to try to find out.

 

Passive pushes forward

Index trackers are increasingly big business, but why has this kind of investing become so popular? In large part, it’s benefited from the steady, stimulus-fuelled rise of the markets over the decade since the financial crash. When markets are rising nicely, and the trends are clear, there’s little incentive to pay an active manager to try to eke out extra gains – especially when they could underperform significantly. For the advocates of active, the advent of more challenging market conditions in 2018 was a welcome chance for the managers to prove their worth.

 

If only wishing made it so

Yet for all the commentary at the start of the year about how uncertain conditions, a greater dispersion of returns and a re-focusing on company fundamentals would assist alpha generators, most active managers have so far singularly failed to rise to the challenge as our current Alpha/Beta Allocator makes clear. Results year-to-date show results are in fact weaker than they were in 2017 – with just 31% of European active managers outperforming, down from 44% last year. And those struggles are apparent whether you’re looking at equities or fixed income.

So will passive march on and muscle market share away from active managers? Not necessarily. Market directionality, or the likely lack of, represents a real challenge to this new hegemony but there are other issues at play too.

At Lyxor, we offer both passive and active funds. Of course, we’rebig fans of passive – we’re one of Europe’s leading providers of ETFs, after all – but our research tells us active has a role to play too in any well-balanced, effective portfolio. Our research suggests the continued growth of passive will actually help, rather than hinder, active managers in time. 

 

Changing the perception

The first of our papers explored the link between the past performance of active funds and subsequent fund flows, and also discussed how smart beta ETFs might affect investors’ perceptions of the performance of their traditional active managers.

It showed that the proliferation of these passive funds has increased competition among asset managers which has, in turn, assisted investors. Put simply, the greater availability of smart beta funds has forced active managers to demonstrate they can deliver true alpha – performance above returns generated by exposure not just to the market, but also to systematic factor risks – if they want to continue gathering assets. If they can show, and repeat, that skill, they have nothing to fear from the rise of the ETFs. 

 

Is there an equilibrium level for active and passive?

The second of our papers dug deeply into the question of whether there’s an ideal balance between active and passive management, and whether the finding of that equilibrium would create better outcomes for investors.

It provides evidence that, at some point, the increasing use of passive funds could create more opportunities for active managers – helping them improve their performance and, in turn, increase the fund flows they attract.

It follows that there is a (theoretical) equilibrium market share for active and passive fund managers, although the researchers don’t seek to work out exactly what it is.  

Are we close to reaching that equilibrium? Probably not. It’s quite possible the share of passive funds relative to active could increase substantially from here before active managers are able to exploit the informational inefficiencies necessary to consistently beat the benchmark.

The paper also helps address a criticism sometimes addressed at passive funds: that index trackers are misallocating capital because they invest in stocks without any regard for their price. The authors suggest any such effects should be corrected automatically. That’s because the growing market share of passive funds would create extra opportunities for active managers, helping bring prices back towards fair value.

 

A force for good?

Claims active asset management is in terminal decline are are in fact exaggerated. In fact, the studies we sponsored show active management should actually benefit from the readier availability and greater use of passive strategies.

Ultimately, the increased role of index-based investing is more an opportunity than a threat for active managers. It creates a more effective equilibrium where each management style has a distinct role to play.

Based on the findings of our researchers we believe there’s an optimal split between active and passive management, and that the market will find it naturally over time.  Contrary to the hype, the inexorable rise of passive isn’t, in fact, sounding the death knell for active managers, although “middle of the road” managers – those managing close-to-benchmark portfolios – may lose out.

The more investors move toward passive strategies, the more active managers should be able to outperform and therefore attract inflows, until the point where they can no longer outperform (because their informational advantage wanes) and flows move back into passive funds.

And of course passive and active strategies don’t act in isolation – there are external forces at play. Developments in the markets, for example, could have an impact on their performance potential and, in turn, how attractive they look to investors. Passive strategies have been helped by the market’s consistent rise over the past few years, but that won’t go on forever. We’ve already seen the return of volatility over the past few months, and that’s still the kind of environment that creates opportunities for the better active managers.  There’s little doubt less effective managers will get left behind.

Read our new report:

alpha beta

Look no further than Lyxor

If you’re uncertain about which investment style to choose in any market, look no further than Lyxor’s ETF Research team. Each quarter it publishes the Alpha/Beta Allocator, designed to give you the lowdown on the markets where passive works best and where it might be worth paying more for an active manager’s skill. And if passive looks most promising then why not choose us? Over the years, we’ve built up one of the most exhaustive, innovative ranges of equity, fixed income and commodity ETFs your money can buy.

Explore our range


For professional clients only. All views & opinion are sourced Lyxor Cross Asset & Lyxor ETF  Research teams as at November 2018 unless otherwise stated. Past performance is no guide to future returns.   

This document is for the exclusive use of investors acting on their own account and categorised either as “Eligible Counterparties” or “Professional Clients” within the meaning of Markets in Financial Instruments Directive 2014/65/EU. These products comply with the UCITS Directive (2009/65/EC). Société Générale and Lyxor International Asset Management (LIAM) recommend that investors read carefully the “investment risks” section of the product’s documentation (prospectus and KIID). The prospectus and KIID are available free of charge on www.lyxoretf.com, and upon request to client-services-etf@lyxor.com.

The products mentioned are the object of market-making contracts, the purpose of which is to ensure the liquidity of the products on the London Stock Exchange, assuming normal market conditions and normally functioning computer systems. Units of a specific UCITS ETF managed by an asset manager and purchased on the secondary market cannot usually be sold directly back to the asset manager itself. Investors must buy and sell units on a secondary market with the assistance of an intermediary (e.g. a stockbroker) and may incur fees for doing so. In addition, investors may pay more than the current net asset value when buying units and may receive less than the current net asset value when selling them. Updated composition of the product’s investment portfolio is available on www.lyxoretf.com. In addition, the indicative net asset value is published on the Reuters and Bloomberg pages of the product, and might also be mentioned on the websites of the stock exchanges where the product is listed.

Prior to investing in the product, investors should seek independent financial, tax, accounting and legal advice. It is each investor’s responsibility to ascertain that it is authorised to subscribe, or invest into this product. This document is of a commercial nature and not of a regulatory nature. This material is of a commercial nature and not a regulatory nature. This document does not constitute an offer, or an invitation to make an offer, from Société Générale, Lyxor Asset Management (together with its affiliates, Lyxor AM) or any of their respective subsidiaries to purchase or sell the product referred to herein.

Lyxor International Asset Management (LIAM), société par actions simplifiée having its registered office at Tours Société Générale, 17 cours Valmy, 92800 Puteaux (France), 418 862 215 RCS Nanterre, is authorized and regulated by the Autorité des Marchés Financiers (AMF) under the UCITS Directive (2009/65/EU) and the AIFM Directive (2011/31/EU). LIAM is represented in the UK by Lyxor Asset Management UK LLP, which is authorized and regulated by the Financial Conduct Authority in the UK under Registration Number 435658. Société Générale is a French credit institution (bank) authorised by the Autorité de contrôle prudentiel et de résolution (the French Prudential Control Authority).

Research disclaimer

Lyxor International Asset Management (“LIAM”) or its employees may have or maintain business relationships with companies covered in its research reports. As a result, investors should be aware that LIAM and its employees may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Please see appendix at the end of this report for the analyst(s) certification(s), important disclosures and disclaimers. Alternatively, visit our global research disclosure website www.lyxoretf.com/compliance.

Conflicts of interest 

This research contains the views, opinions and recommendations of Lyxor International Asset Management (“LIAM”) Cross Asset and ETF research analysts and/or strategists. To the extent that this research contains trade ideas based on macro views of economic market conditions or relative value, it may differ from the fundamental Cross Asset and ETF Research opinions and recommendations contained in Cross Asset and ETF Research sector or company research reports and from the views and opinions of other departments of LIAM and its affiliates. Lyxor Cross Asset and ETF research analysts and/or strategists routinely consult with LIAM sales and portfolio management personnel regarding market information including, but not limited to, pricing, spread levels and trading activity of ETFs tracking equity, fixed income and commodity indices. Trading desks may trade, or have traded, as principal on the basis of the research analyst(s) views and reports. Lyxor has mandatory research policies and procedures that are reasonably designed to (i) ensure that purported facts in research reports are based on reliable information and (ii) to prevent improper selective or tiered dissemination of research reports. In addition, research analysts receive compensation based, in part, on the quality and accuracy of their analysis, client feedback, competitive factors and LIAM’s total revenues including revenues from management fees and investment advisory fees and distribution fees.

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