Where active strategies are still seen as essential
The boom in passive investment strategies and vehicles is an existential threat to active fund managers – and the handsome fees they ask for – but if institutional investors want to move into loans and emerging markets, then active managers still have an important role to play.
That was the message from a mixed panel of asset owners and managers when grilled on stage at the 8th Institutional Investment Forum Japan about whether pricier active managers were still worth it given the swelling alternative of lower-cost passive products, including exchange-trade funds.
Among them was Tokihiko Shimizu, head of the investment banking division at Japan Post Bank, who cited the examples of the Chinese loan market as well as the mortgage market in Australia.
For different reasons both of these markets have seen traditional lenders withdraw, which has opened up a space for alternative lenders to step in and fill. But as with other niche investments, these markets are also less transparent and less index-friendly, so a poor passive fit.
“The non-bank lenders will fill that void out, so it is quite natural to try and capture this alpha opportunity via active managers. But the overall discussion about active and passive is relevant, especially nowadays where institutional investors, namely pension funds are shifting more to the passive side and index funds,” Shimizu said.
A major source of criticism are the fees that active managers charge, without the higher performance and alpha to show for it.
For Eric Stein, co-director of global income at Boston-based investment firm Eaton Vance, these fees are to some extent pushing investors into passive alternatives.
He said active managers were bringing this trend upon themselves by index hugging, not least in the big developed markets where a lot of capital is turning to passive products because many some managers are not being active enough to justify the fees they charge.
“For managers to continue to offer value proposition to clients you have to be more active and more concentrated on, for instance, large-cap equity. It will mean that some will outperform a lot while others will underperform, but there could be some potential for rejuvenation,” Stein said.
INFORMATION ASYMMETRY
He agreed with Shimizu that in less developed markets, including many emerging and frontier markets and also debt markets, active strategies could create alpha. In these markets, the basis for passive strategies are not present, according to Stein.
“When you look at markets with more information asymmetry, those are the markets that continue to thrive for active management – or markets where investors cannot get access through passive alternatives, Stein said. “Investors should not look at indexes, but the quality of the passive alternatives, whether it be a fund or an ETF, and compare that to active managers.”
The information asymmetry varies hugely, though, meaning some emerging markets are increasingly seeing the influence of passive investment strategies.
Take Employees' Provident Fund, India’s biggest pension fund, when it began investing in equities three years ago it did it all through ETFs, said Rajeev Radhakrishnan, head of fixed income at Mumbai-based investment firm SBI Funds Management.
That, in turn, has helped to drive demand for passive products from other investors in India.
Yet on the debt side, India still doesn't have an investment index that can be used as a basis for passive investing, Radhakrishnan said.
So in that Indian market, at least, the active manager remains indispensable.
But back among the equities, interest is growing in more sophisticated forms of index-tracking too.
“There have been some moves towards getting in on equity side smart-beta strategy,” Radhakrishnan said. “So maybe down the line India probably has space for those strategies as well in the market.“
When questioned about the continued relevance of active managers, Eaton Vance’s Stein said the bar had been raised by the passive competition; investor demands are now higher than 10-15 years ago.
As a result, active managers not only have to beat their peers but have to be better than the cheaper passive alternatives.
“To some extent, institutional investors have a fee budget and an active budget, and you have do something to earn that level of fee and persuade them not to go passive. Five to 10 years down the road it will make us better active managers than we would have without these passive alternatives, but we are certainly in a big shift in that regard,” Stein said.