Active Managers Get the Cold Shoulder
By CRAIG KARMIN
A growing number of big investors are concluding that stock and bond pickers failed to add any value during the market turmoil and are shifting to index funds, a move that threatens to cut profits for asset managers.
"Active managers have not given us the added performance in a down market that we hoped for," says Bill Atwood, executive director of the $9 billion Illinois State Board of Investment. Disappointing returns by some large- and small-stock managers led his fund to move about $400 million to index funds.
"Now that we think we're close to the bottom, we feel we can access the upside just as well with index managers," Mr. Atwood says.(of course the future direction of the market should be irrelevant to the choice of active or passive manager but that's a discussion for another time)
The move toward more-passive investments is part of a broader reconsideration by many investors about what went wrong in 2008 and how they can reposition their portfolios to avoid a rerun of that dismal performance. ....A
In a recent survey by Greenwich Associates, a Greenwich, Conn., consulting firm, about one in five institutional investors said they have recently shifted money away from active managers and into passive index strategies. That is up from just 4% who expected to make that shift when asked from July to October 2008.....
Mr. Keleher says the moves primarily involve switching from traditional "long-only" active asset managers who invest in stocks and bonds but generally don't hedge or use derivatives, rather than from hedge funds or private-equity firms.
A change of heart in the $2.3 trillion public pension industry could quickly slice profits for the large asset managers that serve them. Stock index funds may charge annual fees of less than 0.1% of the money they manage, rarely topping 0.5%; stock pickers charge fees that can range from roughly 0.3% up to 2% of assets. Fees for bond managers are generally lower.
Greenwich Associates says that not all of the switches to index funds will be permanent and that some investors will stash their money in index funds until they find new managers.
That is partly true for the Fire & Police Pension Association of Colorado, a $2.5 billion pension fund. Chief Investment Officer Scott Simon says he is winding down a derivative-related program, known as portable alpha, and holding those assets for the time being in stock-index funds. The Colorado fund has about 60% of its stock holdings in index funds, up from 40% in 2008.
While that figure may come down, he says he intends to maintain a greater index bias going forward. "I see passive being a bigger piece of the portfolio than it has been in past," he says. "More managers seem unable to beat their index."
Mellon has found that some pension investors are doing the same thing with their debt holdings. Historically, the difference in performance between the top quartile and bottom quartile of bond funds was about half a percentage point, Mr. Keleher says.
Last year, that gap widened to about six percentage points. Rather than try to pick winners, many institutional investors are more worried about being stuck with losers, so they now are choosing index funds.
All of the above makes perfect sense to me yet in the WSJ's blog "the wallet". We get more of the illogic constantly presented by the mutual fund industry to justify active management. Here is part of the entry:
The Big Money’s Moving Into Index Funds. Should You?
Journal reporter Jeff D. Opdyke writes:
In recent weeks, big institutional investors—the folks paid to invest money on behalf of others—have been making some noteworthy changes to their portfolios. And that has us wondering whether those of us who manage our own 401(k) and brokerage accounts should be shadowing the so-called smart money these days?
As a WSJ story notes today, a new survey by Greenwich Associates shows that roughly one in five institutional managers has shifted money to cheaper, passively managed index funds and away from more-expensive, actively managed funds. Their thinking holds that active fund managers failed to add much value as asset markets the world over imploded during the meltdown, so why pay high fees for mediocre performance?
That report prompts us to wonder: Should everyday investors consider falling in line with the pros?
Indexing is widely considered a smarter way to go, and not just because it’s a cheaper way to invest. Most of us individual dart-throwers don’t have the time or inclination to properly manage a portfolio of individual stocks and bonds, and with indexing there’s not a whole lot of need for that....
But there is a flaw in the logic. From Oct. 9, 2007 (when the S&P peaked at 1565) to Mar. 5, 2009 (the S&P trough of 682), passively managed, or index, funds actually underperformed their active counterparts, according to Morningstar data. The score: passive funds were down 45% on an annualized basis, while active funds were down 43.5%. Since the March low, active funds have risen 37.7%, while index funds are up 41%....
The reason index funds lagged on the way down and have done better so far on the way up could be that an index fund has a mandate to remain fully invested in the index it tracks, no matter what. That means it cannot dive out of underperforming sectors.
Active managers, by contrast, can flee bad investments and go to cash, though too often those moves come a tad late. In down markets that means index funds may suffer more, though in the initial stages of a rebound an index fund’s full exposure means it’s likely to benefit sooner as the active crowd remains on the sideline.
Thus, there’s not really a clear-cut answer as to whether you should be following the smart money into index funds.
(sorry if i missed the logic here: On the downside active managers can "flee to cash though too often they do so too late" and by being late in getting back into the market they often miss the move up compared to the fully invested index funds. So it seems that simple logic would argue it is more risky to depend on that active manager being correct in timing when to go from cash to stocks and vice versa rather than to index)
Going into an index can make a lot of sense for investors who feel burned by their own investment missteps in recent years. Then again, if you find an active manager with a long history of outperforming the indexes, even if the fees are greater, skipping the passive for the active can still be better for your portfolio.
The logic above also escapes me. Volumes of research shows that past performance of mutual funds is a poor predictor of future performance. So finding an active manager with a long history of outperforming the indexes and then investing with him instead of indexing would not be a particularly sound investment decision. Ask those who invested recently with the Bill Miller's Legg Mason Value Trust. But I guess you can add this WSJ blogger to the "hope springs eternal" camp.
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