Much like robo advisors have done in the area of wealth management, passive asset management and the products associated with it are gaining in popularity among investors, putting further pressure on active managers to beat the market and generate coveted alpha. $1.06 trillion departed active U.S. equities over the past five years ending Q1 2016, while $38.7 billion entered passive ones. Furthermore, a Boston Consulting Group report stated that passive products will comprise 42 percent of institutional and retail strategies by 2020. The attraction of low-cost index products among investors and large firms is understandable in an age of lower returns, macro volatility, and strong regulations, with both looking for a stable long-term growth strategy.
“Our five-year return assumptions have steadily moved lower since the financial crisis, amid weak global growth prospects, easy monetary policy and rising valuations,” BlackRock Inc.’s Global Chief Investment Strategist Richard Turnill said to Bloomberg. “We have lowered our assumed returns for most fixed income assets, following a drop in yields (and rise in valuations) in the second quarter.” Turnill went on to assert that a five percent return will be impressive for most asset classes.
The current state of global assets under management (AUM) is virtually flat, with levels rising just one percent year over year to $71.5 trillion. Combine that component with those aforementioned, and any observer can quickly interpret what such an amalgam means for the margins of asset managers and their respective firms. With manager fees falling and net revenue down 1.5 percent year over year, large firms like UBS are expanding their outsourced CIO offerings and trimming costs to offset the margin drop. Mergers and acquisitions are considered a “when,” not “if” prediction by those within the industry, and some firms have started reducing headcounts due to AUM outflows.
In another Bloomberg interview, Aviva Investors Head of Multi-Assets Peter Fitzgerald addressed this move towards consolidation and passive investing: “As regulatory and distribution costs increase materially for asset managers, I don’t think that’s an unrealistic thing to expect. However, there is still an opportunity for those small asset managers to generate relatively high performance and alpha, which is very elusive for the very large businesses. And the very large businesses, almost by default, find themselves pushed into that passive area for the majority of their business.”
The Entire Sky May Not Be Falling
With departures and consolidation come reduced direct competition and a new proposition. The remaining active managers, by leveraging machine learning and predictive analytics technologies to garner insights and achieve alpha, must market themselves and their strategies as more capable and consistent than passive products. Glenn Davis of Eager, Davis and Holmes, a strategic consultancy, sees this convergence as an opportunity for successful managers to beat benchmarks in a less crowded environment, thus netting a better result than otherwise would be the case. “The challenges that they face today have been in place for a very long period of time,” he said.
In order for managers to hold a strategic edge over the shortcomings of passive products and invest with their clients’ best interests in mind, they will need a detailed, customizable approach and an engaging, yet compliant repository of collateral that speak to an individual’s or institution’s investment goals and strategic visions. Technological platforms that centralize access, facilitate oversight, automate updating processes, and capture data will provide adaptive active managers with greater value and proactive firms with a cost efficient competitive advantage.
As Davis underscores, “Active managers who work hard to really understand their clients’ mindsets and motivations can defray much of the pressure from passive management.”