Passive Management Takeover

Morningstar recently released asset Managers’ inflows and outflows of 2014 in a survey to rank the top mutual funds. The biggest winner by far was Vanguard, which gained 291 billion dollars of business last year. Many other passively managed mutual funds had increased inflows as well. Meanwhile, PIMCO, previously considered one of the best fixed-income funds during Bill Gross’s reign, lost 175 billion.

The important factor with this big shift away from active managers is the rationale. Loss of faith in portfolio managers may be part of it, but the greater influence urging casual investors to join Vanguard and similar funds is the dirt-cheap fee. When only 25% of active managers are able to beat their benchmark in the equities asset class, few people see an incentive to go for the much higher 2-20 fee structure. Earlier in the year, John Paulson commented on this trend in an insightful, albeit elitist way. He claimed that hedge funds target sophisticated investors for a reason. Mom and Pop investors would be far more likely to pull money in distress and apparently the value of an actively managed fund can only be seen over the long run.

It’s very common to compare actively managed funds’ returns to their benchmarks, but what Paulson stressed is that not enough people are aware of fund performance during the crisis. While passive funds would have been fully exposed to S&P 500’s 50% drop, active managers would have hedged their bets, limiting downside risk. It’s safe to say that more people have their fates tied to the overall performance of the market than ever before. As long as markets can stay out of trouble, there shouldn’t be a problem, but if benchmarks crash, more people could lose their savings than did in 2007.

-- Sashank Parigi