Index funds much more popular than active funds?

[Brendan Burgess]

I was amazed by this article in today's Irish Times

http://www.irishtimes.com/business/...ugh-life-of-the-modern-fund-manager-1.1820203

Last year, according to Cerulli Associates, $3.4 billion flowed into active funds, while index-based strategies pulled in more than $60 billion.

Could that be correct?

If the ratio of passive to active is 20:1 , it is amazing that the active tail is not outperforming the passive dog. I always thought that passive funds were getting a free ride on the back of a much bigger active funds industry with thousands of analysts making the market, more or less,efficient. But if such huge funds are moving passively, surely there is an opportunity for active fund managers to outperform?

 

[Jim2007]

Could that be correct?

Nothing surprising there, times have changed and investors have learned some lessons over the past few years:

Asset managers are finding it very difficult to interested clients in any of the exotic products they used to peddle and so most of the large players such as DB, UBS, CS, RBS, HSBC and so on have moved into the ETF/Index fund market.

With the squeeze on asset managers have suddenly discovered a taste for selling their competitors products as well as there own - anything to turn a fee... There was a time if you went into say Schroders the only thing on offer was their own funds plus a select few... that is not the case anymore

The reality is that we've gone from a time where asset manager's margins were measured in percentages to today were we talk in base points!

But if such huge funds are moving passively, surely there is an opportunity for active fund managers to outperform?

Not at all, it is very difficult for an active manager to beat an index on a regular basis, because they start with several disadvantages:

- Liquidity: the have to keep a certain amount of the fund in cash to respond to withdrawals etc... so they are challenged to not only replicate the performance of with less that the full amount under management, but to actually out perform it.

- Retain the clients: Clients expect their fund to be filled with the top performers - which means that managers are often forced to buy and the top and sell at the bottom, rather than the other way around! You just have to look at the order book of any major stock exchange on the day a major stock reports to see the blocks of shares being sold before the call, only to be purchased again afterwards if it went OK!

- Legal restrictions: Many active funds can not operate the same way an index fund can for legal reasons

- Costs: Index funds are very mechanical and can be easily automated, active funds on the other had have a lot of costs associated with their operation.