Here’s another take on the great active vs passive debate: in markets where passive funds are more prominent, active fund managers do more of what they are well-paid to do – take more active bets.
Not only that, in these same markets where index funds get more business and charge less, active funds charge lower fees to investors.
In other words – the greater the competition from index funds, active fund managers should produce better returns (although higher active share can also deliver sub-index performance) and deliver more of those returns to investors.
Sounds obvious? Well as the old saying goes ‘It seems to work in practice, let’s see if it works in theory.’
The theory, it seems, is proved by a paper in the Journal of Financial Economics by Martijn Cremers, professor of finance at University of Notre Dame and colleagues. The academics have really done their homework, looking at no fewer than 32 investment markets around the world to reach their conclusions.
So for example in the US, spiritual home of passive index funds (and where they have 27% of total assets), investors pay a total 1.31% for truly active funds and a measly 0.26% for truly passive funds.
In the UK – where index funds have just a 9% market share - investors pay 2.38 per cent for active managers and 0.62% for passive funds.
Not only that – Cremers reckons closet indexers – the pantomime villains of the investing world charging active fees for essentially copying and pasting the index into their portfolios – still have a 32% market share in the United Kingdom but just take up 15% of the headspace in the United States.
It could be worse. Weep for Polish investors if you will. Cremers reports a total absence of index funds there. Closet indexers have a whacking 58% market share and you’ll have to fork out a massive 3% to pay for a truly active fund.
It’s fascinating stuff, vividly brought to life in a recent blogpost at Alpha Architect by Milan-based Elisabetta Basilico, a quant investment expert and consultant who specialises in what she terms ‘turning academic insights into investment strategies’.
Apart from doing that with some aplomb, Basilico, it seems, also has something of a wry sense of humour.
She introduces her blog post with a quote from perma-grump hedgie Crispin Odey (above) who said recently that:
Money managers specializing in picking stocks and bonds are being driven out by mindless passive investing’
That will be the same Odey, she notes, ‘whose flagship fund lost almost 50% in 2016.’