Research that just recently earned both Eugene Fama and Robert Shiller Nobel Prizes in economics provides valuable insight into the future landscape of mutual fund/ETF managers.
The takeaways? Insight into 1) the active vs. passive debate, which is not going away anytime soon, and 2) the migration of assets into ETFs from mutual funds. (While total AUM among ETFs is still far below that of mutual funds, in the last five years, the amount of assets tied to ETFs in the U.S. has tripled, according to BlackRock data.)
In the most simple of terms, Fama's Nobel work shows that active managers are set to lose to indexes. His research claims that it is increasingly difficult for managers to outperform the broader market over the long-term because the market is efficient - investing tenets that have influenced the likes of Vanguard and Dimensional Fund Advisors. That's good news for equity ETFs - the vast majority of which are index-based - and passively-managed mutual funds. Bad news for the more than 7,000 active equity mutual funds in the market.
"As most active mutual funds fail to outperform a benchmark and as investors gain comfort with ETFs, we think ETFs will continue to gather assets for their transparency, low costs and market performance," says Todd Rosenbluth, director of ETF and mutual fund research at S&P Capital IQ. "Investors should question whether they should pay to not outperform the market," he says.
Interestingly, the Nobel Prize was shared by someone who had a slightly contrasting view. Shiller's work, meanwhile, found that there are times where active management is worth it since markets aren't always properly priced. Why? Because you have instances such as our current environment where central banks are pumping so much liquidity into the market that it creates a bubble and overvaluation. In other words, markets can be overpriced or underpriced at times, creating opportunities to buy and sell stocks.
Garb Mechigian, senior managing director of CTC Consulting, argues that the only way for active mutual fund/ETF managers to add alpha is through 1) portfolio concentration, owning less stocks, 2) using leverage to help add alpha and increase returns over the market and 3) investing in illiquid securities where the market isn't as efficient.
Bottom line for fund managers: While managers must take into account the global economy to judge the mispricing of assets and where there's opportunity for alpha, the active management industry is challenged by research suggesting investors would be better served looking to alternative approaches. Research shows that the best way to gain exposure to equity securities at a low cost is via passive management through index based products. Passive mutual funds/ETFs will therefore continue to gain steam.
