Monday, September 25, 2017

Which investment style has dominated over the long haul, active or passive?

Active vs. passive performance trends have been cyclical, with each experiencing its own periods of dominance. It is widely believed that the Morningstar Large-blend category (stocks in the top 70% of the capitalization of the US equity market where neither growth nor value characteristics predominate) is the most efficient category, or one that would customarily favor passive investing. However, even this category shows the cyclical nature of active and passive performance. Currently, we are experiencing a period of time when the performance of passive large blend funds is trouncing those actively managed.

So, where are investors putting their wallets? Based on monthly asset data from Morningstar dating back to 1996, passive assets within domestic equity totaled less than $50 billion, accounting for less than 8% of U.S. equity assets. Actively managed assets totaled approximately $600 billion by comparison. Clearly, passive investing was not even wrestling in the same weight class as actively managed. However, by September 2016, passive assets had increased over 3,500% and stood at nearly $1.7 trillion, representing almost one-third of domestic equity assets.

During this same time period, active assets grew by less than 20% to reach approximately $3.6 trillion, despite meaningful market appreciation. The percentage allocation to passive has consistently trended upward over the past 20 years. As the graph below depicts, not only are asset flows to passive funds hitting new records ($504.8 billion in 2016), active funds are experiencing significant outflows ($340.1 billion). In fact, the outflows in 2016 were even higher than during the financial crisis of 2008, when active funds saw outflows of $208.4 billion.

This trend toward passive investing is fueled by the fact that few active managers have been able to consistently outperform their benchmarks and peer groups over time, especially within the large cap asset class. This statistic is even more compelling when you factor in the survivorship hurdle. Simply put, many funds simply fail. John Rekenthaler from Morningstar recently reported that only 34% of U.S. large-company funds finished the 15-year period. The largest hurdle for active managers to overcome is the fee advantage passive strategies possess. It is challenging for active managers to consistently outperform their benchmark net of fees. Meanwhile, as assets continue to flow to passive strategies, providers such as Vanguard are able to capitalize on their scale and lower fees even further.

In Active vs. Passive Investing Styles: An Age Old Rivalry, SBS traces the origins of the active and passive investing styles, dives into the historical performance and asset flow trends of each, and addresses how plan sponsors can make prudent decisions about employing each investing style.

If you have any questions, or would like to begin talking to a retirement plan advisor, please get in touch by email or by calling (855) 882-9177.

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