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Money managers under the microscope

Passive, aggressive

October 1, 2010

CHINAThe days when active managers could ride a market rally and charge high fees for doing so could be drawing to a close. Passive managers are hoping to paint their active rivals into a corner by delivering better than market returns at a lower cost. The development of so-called “smart beta” products based on non-traditional benchmarks is expected to force active managers to sharpen up or get out of the game.

Fundamental indices, which use a variety of criteria to weight stocks, and minimum volatility indices, are beginning to gain traction with institutional investors.  The latter, developed by MSCI for fund firms running managed volatility strategies, aim to deliver close to market returns but with about a third less risk, giving a better return per unit of risk, thereby improving the overall efficiency of an institutional investor’s portfolio.

BlackRock’s head of index equity, Eleanor de Freitas, said that to date investors were dipping a toe in the water, using these types of index as a complement to their core passive portfolios.  “All our client queries at the moment are from existing index clients. We don’t view these products as an alternative to active investing,” she said.

But with exchange traded funds also gaining in popularity – Lipper FMI data show that in the first half of 2010 they made up 40 percent of net sales in equity investments (see below) – it looks like the writing could be on the wall for active managers that can’t actually outperform.

ETFs vs equity

(Net sales figures for equity funds and ETFs from Lipper FMI)

Finding genuine alpha in developed markets is becoming increasingly difficult in any event – the widespread availability of information and the efficiency of price discovery in such markets means that many active managers struggle to find an edge. The ability of passive managers to deliver better than market returns by applying systematic tilts to indices is only adding to the pressure.

“What used to be called alpha is now more readily available in a beta format, so it is continuing to turn up the heat,” said Hugh Cutler, head of distribution at passive giant L&G Investment Management. “But the biggest problem for active managers is that they underperfom the market on aggregate anyway.”

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