Originally published by OpenMarkets
Scrolling through LinkedIn (NYSE:LNKD) last week, I was shocked by a headline – "Passive to overtake active in US by 2024, says Moody’s".
Wowza! A fair chunk of my working life has been spent working for (active) funds managers, and the thought that their days might be numbered is disturbing. While there has been enormous growth in passive investment, often at the expense of active managers, surely this can’t be the end of the road? This growth in passive investment has come during a prolonged bull market that history tells us will—eventually—end. This is where active managers earn their money, helping protect investors from the worst the bears have to throw at them.
Moody’s based its analysis on redemptions in the US from actively managed funds over the past decade versus inflows into passive equivalents. Is the US experience applicable to Australia?
Is it passive versus active, or listed versus unlisted?
Inflow data shows unequivocally that investors’ money continues to flow into exchange traded products (ETPs). However, it begs the question – are investors looking for passive investments or listed investments?
While passive exchange traded funds (ETFs) continue to receive the lion’s share of flows, actively managed listed vehicles, such as exchange traded managed funds (ETMFs) and listed investment companies (LICs) are also growing, both in number and size. An increasing number of (active) fund managers are offering listed versions of existing unlisted managed investments. This trend appears to be uniquely Australian and once which will continue to gain momentum over the coming year.
ETFs (Exchange Traded Funds) – momentum continues
According to the BetaShares Australian ETF Review – End of Year Review 2016, the Australian ETF industry broke records in both funds under management (FUM) and trading activity in 2016. FUM increased by $4.4 billion (or 21%) in 2016, to hit a new high of $25.8 billion.
A mere drop in the ocean when you consider the global ETF industry experienced net inflows of US$389 billion last year, to reach US$3.5 trillion. Yes, that is roughly twice the size of Australia’s A$2.1 trillion of super assets!
The BetaShares report attributed roughly 80% of this growth to new money, while the remaining 20% was driven by asset value appreciation; in other words, it’s not just the bull market driving this growth.
Passive ETFs were the recipient of 89% of net inflows last year, helped along by robo platforms that take an investor’s money and invest it in a portfolio of ETFs according to that individual’s risk profile. Platforms like the innovative round-up app Acorns or the cutting-edge robo-advice firm Six Park. Such platforms resonate with millennials…the next generation of investors.
When ETFs first emerged in Australia, they were quite vanilla. Funds replicated broad market indices such as the S&P/ASX 200, S&P/ASX 100 or MSCI World Indices. As time passed, ETFs became more sophisticated and we saw the emergence of:
- smart beta ETFs, those that use alternative index construction rules instead of the typical cap-weighted index strategy and may consider factors such as size, value, dividends or volatility; according to BetaShares, smart beta products captured 25% of net inflows in 2016
- ETFs built around a greater range of narrow market sectors – gold and commodities, emerging markets, and a range of geographic or sector specific indices
- Niche products – 40 new ETFs were launched in 2016, including a range of niche products that include BetaShare’s HACK, built around the Nasdaq Consumer Technology Association Cybersecurity Index and FOOD, focused on the Nasdaq Global ex-Australia Agriculture Companies.
The development of niche products will support continued ETF growth, and provide Australian investors the opportunity to benefit from investing in sectors and thematics relevant to the world today.
EMTFs (Exchange Traded Managed Funds) – product development a go-go
This is one sector that will ensure the continued relevance of the active fund manager. The launch of the first Exchange Traded Managed Fund (EMTF) in 2015 was world leading – in fact, the rest of the world hasn’t yet untangled the regulatory red tape to offer similar products.
ETMFs received 11% ($400 million) of net inflows in 2016 and fund managers clamoured to get products listed, including:
- AMP Capital teamed up with BetaShares to launch three of their existing unlisted products as ETMFs
- Magellan launched a third ETMF, off the back of its trail-blazing success with the Magellan Global Equities Fund
- Schroders (LON:SDR) joined the party, launching its real return fund, GROW.
No doubt 2017 will see more managers seek a share of the ETMF action.
A surge in LIC (Listed Investment Company) listings
At 31 January this year, there were 96 LICs listed on the ASX – a far cry from the days when the sector was dominated by the big two, AFIC and Argo. While they remain the giants of the sector in terms of size and transaction volume, there’s a lot more competition these days.
Why would a manager list a fund as an LIC? The closed-end structure allows the investment manager to focus on investment selection and portfolio management without having to factor in fund inflows or outflows. From an investor’s perspective, shares in LICs are easily transacted on an exchange, and, because they trade at either a discount or premium to net asset value, can be often by traded in a way that’s beneficial to the investor. Because of the company structure, LICs generally pay fully franked dividends…and who doesn’t like their income with a tax benefit?
Moody’s headline isn’t relevant to Australia. Passive investment will continue to grow, of that there is no doubt…however, innovation in product development and clever fintech solutions, along with a regulatory environment that is (relatively) supportive, will ensure active managers continue to hold their own.
General Advice Warning: The information provided in this post is general information only and is not designed for the purpose of providing personal, financial or investment advice. Any examples are presented for illustration purposes and past performance is not a reliable indicator of future performance. The information provided does not take into account your particular investment objectives, financial situation or investment needs.