Active managers choose the stocks or bonds they think have the best chance of beating market returns. Passive managers merely try to match a market index and can therefore charge lower fees. The debate about which is best to manage our savings has raged for decades.
2014 has been disappointing for active fund managers with less than 10% of them failing to beat their assigned benchmarks. This has resulted in large outflows from actively managed funds, particularly in the US market, where overall, in the past 12 months, redemption’s have exceeded new sales by $92 billion. Meanwhile, the money from institutional and retail investors has instead flowed strongly to their rivals, passive funds, which have taken in net new funds of $156 billion.
Fidelity Investments, once the world’s largest fund manager, saw $24.7 billion flow out of its active funds this year; Vanguard, its successor as the largest US mutual fund group, took $188.8 billion into its passive funds. It is estimated that 20% of all European pension funds are invested in passive funds and this is expected to double over the next five years.
The flow out of active funds is driven in particular by the phenomenon of exchange traded funds [EFTs], passive vehicles that can trade directly on a stock exchange. EFTs now have $2.76 trillion in assets globally and so far this year about $275 billion in new money has flowed into them.
The problems of active managers create dangers; somebody has to do the job of setting a sensible price for shares so that capital will be efficiently allocated to where it will do most good. Index funds do not do this and merely accept any price on offer.
The more money that goes into passive funds, the dumber they will become and more prone to massive overshoots. Active managers’ problems have also been affected by central banks intervening in the market on several occasions, to stop share prices correcting. Indexing may cause investment bubbles because all new money coming in is automatically allocated to companies with the highest values.