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The Death of Active Management Has Been Greatly Exaggerated

Active investing will never die, but it’s being forced to evolve.

Ben Johnson, 06/06/2017

It is no secret that actively managed funds are struggling (EXHIBIT 1 ). Over the three-year period ending April 30, U.S.-domiciled actively managed mutual funds and exchangetraded funds witnessed collective outflows of nearly $514 billion. Passively managed mutual funds and ETFs collected nearly $1.57 trillion in net new money during that same span. What began as more discerning culling of positions in underperforming U.S. stock funds has become more widespread. For example, during the 12 months ending Jan. 31, investors pulled $99 billion from funds that beat their Morningstar Category indexes over that same period.1

Are we approaching the End of Days for active management? I don’t believe so. In my opinion, active management will never die. There will always be investors who hope for something better than getting the market’s return net of a small fee—it’s human nature. But active management must continue to evolve. Here, I’ll take a closer look at two ways in which active management has changed in recent years as evidenced by:

1 The growth in the active use of passive funds.
2 The expansion of a class of nominally passive funds that make active bets.

Both phenomena demonstrate that active management is alive and well and that the distinction between active and passive is as blurry as ever.

Investors Are Getting Active With Passive
The objects of many active managers’ decision-making process are changing. Instead of choosing between Coca-Cola KO and Apple AAPL, many active managers are deciding between U.S. large caps and U.S.-dollar-denominated emerging-markets debt. These active asset-allocation decisions are increasingly implemented using ETFs and index mutual funds. The managers making these decisions are doing so in a number of different settings and with varying degrees of activity. These range from broadly diversified strategic asset-allocation models that are managed at intermediary platforms’ home offices to so-called robo-advisors and ETFs of ETFs. Among these actors, the preference for passive is strong. In trying to generate alpha by recombining various beta building blocks, many asset allocators want to take ownership of all active decisionmaking rather than outsource it to a traditional security selector.

The growth of these model-builders is most readily measured by the increase in assets under management of target-date funds, the assets under management or advisement in ETF managed portfolios, and the amount of money managed on digital advice platforms (aka robo-advisors).

Assets in U.S.-domiciled target-date funds stood at $880 billion as of the end of 2016.² Of that sum, 39%, or $343 billion, was invested in target-date series that use passive funds exclusively. These series’ share of the target-date market increased from 17% as of 10 years ago. ETF managed portfolios are investment strategies that typically have more than 50% of portfolio assets invested in ETFs. Primarily available as separate accounts in the United States, these portfolios represent one of the fastest-growing segments of the managed-accounts universe. As of Dec. 31, Morningstar was tracking 881 strategies from 162 firms with total assets of $84.8 billion in this space. This is just the tip of the iceberg, as there are tens of billions of dollars invested in similar strategies that are managed by teams at a number of different intermediary platforms, which are not captured in our database. Lastly, there are the robo-advisors. Firms like Vanguard and Charles Schwab SCHW have seen rapid growth in the adoption of their digital-advice platforms. Schwab Intelligent Portfolios were home to $16 billion in investors’ assets as of the end of March. Vanguard’s Personal Advisor Services segment now oversees more than $50 billion.

Ben Johnson is Morningstar’s Director of European ETF Research.

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