Mark Dampier: Passive smugness could come back to bite investment advisers

Parts of the asset management industry are going through the most painful patch they have ever seen. I say ‘patch’ but I think we are actually witnessing huge secular change.

Just look at some of the share prices of UK asset managers – Jupiter, Miton, Aberdeen and Liontrust, even bigger companies like Schroders aren’t immune.

Part of this has been down to the ongoing unpopularity of UK PLC, with investors deserting it for overseas climes.

The elephant in the room is likely to trample over a good many more business models yet

The US has been particularly favoured and this trend looks to continue, at least for now. Much of the exposure there isn’t even via direct funds but through global mandates – with the US so dominating, most of these funds are quasi-US.

I’m not sure investors are achieving much diversification even though a global label might suggest it.

But all this masks the real change – the rise of passive investing, which is decimating much of the active industry.

Perhaps it was foreseeable. I remember giving a talk at the London Stock Exchange years ago about a new breed of investment vehicle called ETFs. They could replicate indices of all sorts and their structure meant they could be traded every second. They are cheap and, as such, have become simply huge.

Passives are cheaper, outperform the majority of active funds and there is no fund manager risk (something I am only too wounded to know about)

Their success was not an overnight phenomenon. I remember looking at many index funds in the first part of the decade and found them mainly to be third quartile performers. I think may of us were fooled into thinking they weren’t that important.

But perhaps the writing was on the wall. One country stood out, even back then, where active managers struggled – the US. It was always near impossible to find a great active US fund. I might argue Findlay Park was an exception but its success meant it stopped taking new business.

The US has come back from a long flat period between 2000-12 to truly dominate investment flows through a list of incredibly strong companies I don’t need to repeat here.

This has been a game changer for the passive industry. If investors buy past performance, why wouldn’t you look at a passive fund first?

The rise of passive investing is decimating much of the active industry

They are way cheaper, they outperform the majority of active funds and there is no fund manager risk (something I am only too wounded to know about). Use an ETF and you avoid most platform fees, too.

While the active industry is suffering, intermediaries embracing passives have realised they can keep portfolio management costs down, while taking their own fees higher based on the higher value of advice.

Now, I have no problem with the planning part, but what about the portfolio management service? If active is so dead and passive the only way to go, would it not be reasonable to conclude as a client they don’t need it?

If the MSCI indices give me exposure to 1700 stocks, do I need any more than one or two funds, maybe some bonds? All this can be done as a one-off plan

If active fund managers can’t pick stocks, asset allocation decisions are likely to take even more value away. Many asset allocators can’t even get the direction of interest rates right, let alone their level, and in a world dominated by geopolitical events once again, what chance has anyone in getting the event and its consequences right?

If the MSCI indices give me exposure to 1700 stocks, do I need any more than one or two funds, maybe some bonds? All this can be done as a one-off plan. I don’t need a management service.

If there are any drastic changes needed (and according to what I read from advisers on X there never is – “leave the investment alone” is the mantra), then the client can always pay for some one-off advice.

So, I wonder whether the general smugness over the success of passive won’t lead to some being hoisted with their own petard. The elephant in the room is likely to trample over a good many more business models yet.

Mark Dampier is an independent consultant and can be found tweeting at @MarkDampier