The shift from active to passive will cross the line this year

Many investors are ditching active managers in favour of low-cost tracker funds

The Borsa Istanbul stock exchange in Istanbul, Turkey. The shift continued despite benchmarks the passive funds follow wobbling and falling in recent weeks. Photo: Bloomberg

The struggle is on for active managers

David Einhorn closed out 2018 with his biggest annual loss ever for the 22-year-old Greenlight Capital.

The firm’s main hedge fund fell 9 per cent in December, extending this year’s decline to 34 percent, according to an investor update viewed by Bloomberg.

Greenlight posted some of the industry’s best returns in its early years, but has stumbled since losing more than 20 per cent in 2015.

Other value-investing managers have also struggled, as a decade of historically low interest rates and the rise of passive investing and quant trading pushed growth stocks past their inexpensive brethren. Three Bays Capital and SPO Partners & Co., which sought to make wagers on undervalued stocks, closed in 2018. Mr Einhorn has repeatedly expressed his frustration with the poor performance this year, while remaining steadfast in his commitment to value investing.

Greenlight, which posted gains only in May and October, underperformed both the broader market and its peers in 2018. The S&P 500 Index dropped 4.4 per cent, including dividends, while the HFRX Global Hedge Fund Index, an early indicator of industry performance, fell 7 per cent through December. 28.

At the start of the year, Greenlight managed $6.3 billion in assets, according to a regulatory filing. By May, the firm was down to $5.5bn. 

A preference for passive funds over active will approach the tipping point this year.

When it comes to mutual funds and exchange-traded funds that buy US stocks, those that passively track indexes now hold 48 per cent of assets, according to estimates from Morningstar. They will top 50 per cent in 2019 if the current trend holds.

That would mark a tipping point for the investing industry, which for decades built its stature on the prowess of stock-and-bond pickers seeking to beat the markets. In recent years, investors have ditched those active managers in favour of ETFs and other index funds, which typically offer a way to get market exposure at far lower fees. The shift continued this year even as the benchmarks the passive funds follow wobbled and fell.

“I’d expect the trend from active to passive to continue,” says Benjamin Phillips, a consultant with Casey Quirk. “It’s not simply investors grabbing the tail of the bull - it’s a secular shift in how advisers are building portfolios.”

Passively managed US stock funds increased their market share to 48.1 per cent as of November 30 from 45.7 per cent a year earlier, Morningstar data show.

Beyond US equities, the power balance tilted broadly to index funds in 2018. The move was less pronounced in bonds, where money managers have more consistently outperformed their benchmarks. Investors pulled an estimated $150 billion in the first 11 months of the year from actively run funds across asset classes, excluding money markets. In contrast, they added $395bn to passive funds, according to Morningstar.

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The divide was especially dramatic in November as market volatility picked up. Active funds lost more than $50bn to redemptions while index funds took in a similar amount.

Mutual fund outflows could accelerate if investors cashing out amid recent volatility choose to use ETFs when they reinvest.

“Active mutual fund investors have a history of panicking when things get tough,” says Eric Balchunas, senior analyst with Bloomberg Intelligence. “You tend to see passive gain market share in difficult environments.”

It isn’t all positive for passive funds in 2018. While they added market share, their flows will fall well short of 2017’s record of almost $700 billion in contributions.

Here’s a look at how the biggest fund companies are faring:

Vanguard Group

* The company, which started the first index mutual fund for individual investors in 1976, brought in an estimated $168bn through November in passive funds, Morningstar estimates show. That compares with $329bn for all of 2017.

* The Valley Forge, Pennsylvania-based firm is feeling the impact of diminished flows to ETFs, which are on pace to attract just over $300bn industrywide, versus $467bn last year.

* Still, Vanguard is likely to post higher 2018 inflows than any of its rivals.

BlackRock

* The New York-based firm saw passive inflows of $108bn through November, per Morningstar’s estimate. In 2017, they were $213bn. The pace picked up in November when the firm attracted more than $25bn to its US ETFs - a record monthly haul for the company.

* The world’s largest ETF provider has seen the steepest drop in some of its heavily traded funds that are most sensitive to stock movements.

Fidelity

* The firm saw an increase to its passive products in 2018, gathering $64bn through November, as estimated by Morningstar, compared with $52bn for 2017.

* In August, the Boston-based fund giant introduced the industry’s first zero-fee index mutual funds and cut prices across much of its passive lineup. Explaining her firm’s newfound commitment to passive products, chief executive Abigail Johnson said in an October interview, “If we decide to do something I want to be really good at it".

* On the active side, the firm saw $17bn in outflows, Morningstar estimates. Yet that’s good news since altogether Fidelity’s stock and bond pickers could end up with the smallest annual outflow since 2014.

American Funds

* The Los Angeles company continues to buck the trend by attracting money to its active funds. It added $21.4bn through November, ahead of last year’s total of $16.6bn, according to Morningstar.

* Most of the money has flowed to the company’s target-date retirement funds, which have been gaining market share in recent years.

The struggle is on for active managers

David Einhorn closed out 2018 with his biggest annual loss ever for the 22-year-old Greenlight Capital.

The firm’s main hedge fund fell 9 per cent in December, extending this year’s decline to 34 percent, according to an investor update viewed by Bloomberg.

Greenlight posted some of the industry’s best returns in its early years, but has stumbled since losing more than 20 per cent in 2015.

Other value-investing managers have also struggled, as a decade of historically low interest rates and the rise of passive investing and quant trading pushed growth stocks past their inexpensive brethren. Three Bays Capital and SPO Partners & Co., which sought to make wagers on undervalued stocks, closed in 2018. Mr Einhorn has repeatedly expressed his frustration with the poor performance this year, while remaining steadfast in his commitment to value investing.

Greenlight, which posted gains only in May and October, underperformed both the broader market and its peers in 2018. The S&P 500 Index dropped 4.4 per cent, including dividends, while the HFRX Global Hedge Fund Index, an early indicator of industry performance, fell 7 per cent through December. 28.

At the start of the year, Greenlight managed $6.3 billion in assets, according to a regulatory filing. By May, the firm was down to $5.5bn.