Most of us have had to change the way we work over the last year or so - and it's been interesting. But spare a thought for the asset managers, they were experiencing a change in paradigm before we were - and for the majority of them it's not been a pleasant experience... Read More
In todays article I'm going to look at how and why their world changed and how we've seen that it could be changed back.
Over the last few years we’ve seen a shift in market forces which have impacted asset managers more than most, especially in the field of digital assets.
A combination of long bull runs, technological advancement and comparatively low volatility has caused clients to question the value of active portfolio management.
On top of these factors we have the fundamental misunderstanding of passive management as a strategy.
According to MorningStar, Passively managed funds grew at approximately 5x the rate of actively managed funds during 2020.
So what are the drivers for this change in paradigm and what can the industry do to counter it?
Lets start by considering how asset managers typically make money.
Asset managers typically charge several types of fees, and these will vary by asset manager:
Management fees relate to the asset manager charging a fee to hold a clients assets – whether trades take place or not.
AUM fees equate to the asset manager charging a fee based on the value of assets under management – again, this does not imply that any trades have taken place during a given period. This type of fee typically reduces as the assets under management increase.
Transaction fees are exactly as you’d imagine, a fee based on a transaction that has been performed. So why are investors moving to passively managed funds?
In recent years, actively managed funds have underperformed passively managed funds (in general). Passively managed funds normally have a more economical fee structure and so the investor is able to see a correlation between more consistent results and lower fees compared to higher fees and a more variable result.
It should be noted that there are asset managers who have outperformed the market, but on the whole this has not been the trend.
How can passively managed funds be better than actively managed funds?
This question highlights the misunderstanding of what exactly passively managed funds are.
In the main, passively managed funds are based on indexes, or parts of them. The asset manager will choose which fund a client backs based on the client’s risk profile.
And this is where you should be saying “What?” – because this is the fundamental misunderstanding.
When an index is created, it is created by fund managers and stock pickers – so it is created by the same people that would be managing client funds in an active setup.
So does a passive management strategy reduce the risk of loss – No.
Is a passively management strategy cheaper for the investor – Typically yes
This leaves us with a question, what is the investor gaining by using a passive management strategy? One of the main benefits, aside from cost, is that the asset allocation decisions are taken by more experienced traders which are in theory better at creating a successful allocation – but this is in theory and there’s no guarantee.
So whilst a single passively managed fund may not guarantee success it is possible to allocate a clients portfolio across multiple funds in order to match their risk profile – realistically speaking this is comparable to taking the average of an average in order to reduce risk and move closer to the center of the bell curve of performance.
In theory the best results should still be possible with an actively managed portfolio although it does include a degree of risk - because rather than sticking with an index in order to gain market or better performance the actively managed portfolio would move into and out of assets based on the best possible return at the time.
How can asset managers counter the rise of the passively managed portfolio?
In the wake of the FCA asset management review and subsequent rule changes, along with the US securities and exchange commission ruling regarding the need to behave in the best interest of the client when performing transactions (or providing recommendations); Asset managers will need to be able to perform post trade analysis and report on it.
This is also in line with the requirements of MiFid II (pricing) and PRIIPs (providing simple, complete information for retail clients relating to the offered investment product(s)).
This alone will not facilitate a paradigm shift in asset management strategies or investor adoption of active management.
One of the key, psychological, drivers for investors towards passive management is the understanding of the effect of fees on long term returns. This includes not only the value of these fees but the complexity of them.This is the aspect of active management that could be changed in order to facilitate increased up take of actively managed funds.
The changes that we have seen at CTEX Markets are two fold:
1. Asset managers managing clients funds at the client venue
2. Asset management fees are increasingly based on performance only
We've seen that it is possible for asset managers to manage their own exposure whilst also providing clients with complete transparency - and this is how we think that the market could be convinced to move back towards actively managed portfolios.
CEO – CTEX Markets
CTEX Markets is dedicated to helping asset managers (and portfolio managers) to achieve the best possible results for their clients - so if you'd like to know how our platform could help you, reach out to us - Asset Managers See Less
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