By Sefian Kasem, global head of ETF and indexing investment specialists at HSBC Asset Management
Active asset managers – value managers in particular – have had a hard time since the global financial crisis (GFC). There has been a growing shift towards passive investing at the expense of active management with investors attracted by the lower costs and the performance track record of passive strategies.
Just 17% of European active equity funds beat their average passive peer over the last decade, according to Morningstar’s latest Active/Passive Barometer report.
Indeed, this shift may have cost some value managers who were forced to exit value positions, leading to a reflexive negative spiral and compounding underperformance. But putting the blame on passive encourages an either-or view of active and passive products, when in truth they should be viewed as a complement to one another.
For example, the extensive research and analysis of active managers and the flexibility they have to actively sell and buy stocks can be an important driver of the health of financial markets. A healthy market is critical for passive to perform well.
But more than that, both active and passive investments can be deployed as part of an active investment strategy.
Imagine an investor wants exposure to US equities. They may believe US equities are fertile ground for active management to generate alpha, leading them to select a manager with a specific strategy in the expectation that they will be able to generate above-market returns.
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If however, that same investor does not believe US equities offer stock picking opportunities – or has no view either way – they may choose to simply take the market return via a passive product.
In both instances the passive and active products are market access vehicles that the investor chooses according to their own view.
In this sense the term ‘passive’ feels misplaced as it hides the fact that passive products are used by investors in an active fashion: where they choose to buy, how they choose to manage their position and where they choose to sell are all active positions.
On another front, the popularity of passive products since the GFC has long been seen as having come at the expense of active products. The narrative has been that investors lost their appetite for active, choosing instead to allocate to passive products. There is merit to this argument, but it is not the only compelling explanation.
Another such argument behind the shift to passive funds is the success of the Federal Reserve. The move toward the zero lower bound in the US, along with the numerous quantitative easing packages deployed to support the economy in the aftermath of the GFC, worked exactly as former Fed chair Ben Bernanke said they would – inflating assets via the portfolio rebalancing channel.
The Fed’s reassurance acted as a powerful psychological backstop for investors, encouraging many to invest with the Fed rather than picking a talented active manager who could navigate the challenges associated with a fluctuating market.
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Naturally, many chose to take the option to invest with the Fed, taking the return of the market rather than employing an active manager. This inevitably had a significant impact on flows within the active space.
There are differences of opinion as to whether monetary policy should have remained loose for as long as it did, but there is no doubt that the Fed and other central banks did everything they could to prevent the US from facing a Great Depression-like economic scenario, both around the time of the GFC and the Covid pandemic.
But now that we have entered a period of tighter monetary policy, does this mean that the shift towards passive products will unwind?
As policymakers move away from the use of conventional easing measures, this may open the door for select active management to perform again. By that logic, some might expect investors to begin to turn away from passive management.
This would be a mistake. Passive investment funds should be viewed as market access tools in the same way active funds are.
They broaden the choice for investors, enabling them to express a view on where active stock pickers may be successful and alternatively where they may find alpha generation more challenging, in which case a passive strategy may be preferable. Active and passive should not be seen as opposing choices, but arguably as a match made in heaven.
