A couple of interesting stories to put in the “active versus passive” file.
Story 1:
On October 4th, the Financial Times ran this piece on closet indexing, calling it a tax on millions of investors that pumps asset bubbles, creates no economic benefit and is, in fact, an impediment to capitalism. Closet indexing—wherein an active fund’s holdings are suspiciously similar to what’s in a major index—leads to active management fees being charged for what is essentially a passive strategy. The article stems from a report published in September by SCM Private, an investment advisory firm in London, claiming (somewhat dramatically) that closet indexation is a U.K. “epidemic.” To back up the claim, the report cites some big numbers—based on analysis of £120 billion in U.K. funds, SCM claims investors could have saved £1.86 billion in fees if they had switched from underperforming U.K. equity funds to alternative cheaper index funds.
There’s no case for it, and, according to the article, solving the problem will involve a radical overhaul of how managers are paid.
Story 2:
Over here in Canada, exchange-traded fund (ETF) provider BMO Global Asset Management released a far less polarizing report on that subtle dance between active and passive management—this time related to the interplay between the mutual fund and ETF industries. The report noted that the Canadian ETF industry has grown to approximately $60 billion in assets under management as of September 30. But it also noted a key trend: the convergence of the mutual fund and ETF industries.
More and more, mutual fund managers are using ETFs for tactical allocations and for diversified exposure to satellite investments. ETFs are helping mutual fund managers cope with volatility and swings in investor demand simply because of the nature of the product: they’re liquid and easy to trade.
In this case, when it comes to mixing a passive product into an active one, it’s not so much about the cost as it is about ETFs’ growing role as a trading tool for sophisticated investors.
Why did I put these two stories together in this week’s blog? Because they paint a striking picture of the evolving relationship between active and passive strategies and the increasing intermingling of the two by managers.
In one case, getting too close to a passive strategy within an active fund is considered highway robbery—in another, ETF use among active mutual fund managers is a tactical tool for positioning a portfolio in volatile times.
Between these two scenarios, the evolving ETF space is finding a solid niche in the middle.