Asset Management Market Study: Active or passive? Or just transparent and appropriately priced?
18 January 2017
The Financial Conduct Authority’s (FCA) focus on performance in active asset management is nothing new. But last month’s asset management market study interim report (MS) further underlined its focus.
While active funds generally outperform their benchmark gross of fees, the MS identified that this often leads to underperformance when fees are deducted. The same is true for passive funds - which don’t get the same headlines - as the FCA excuses this as the natural consequence of dealing costs (resulting in a small margin of tracking error to the benchmark).
If you followed the above to a natural conclusion, then you might think the end is nigh for active funds and that investors should flock to passives. But that leaves out some fairly important considerations. In practice, passive funds have a place but can be inefficient for the market. As they simply track performance, there is no ability for the manager to take a view that a certain stock might be over or underpriced; this removes a link between companies’ performance and stock price. Active funds, on the other hand, can help drive market change and ensure companies compete for investment. This can lead to better outcomes for investors - both into funds and directly into companies. Passive funds cannot achieve the same market change. So, on that analysis, it is possible to say you need active funds to allow passive funds to exist.
Also, while the FCA found that active funds generally did not outperform their benchmark net of fees, some do; reliance on an average often hides the true position.
This in part is why investors choose active funds - a risk appetite to chase higher returns, and face higher risk. This active process inevitably attracts higher costs and therefore fees but the benefits can, and often do, outweigh these costs. To draw a parallel, a pure economic model would say that no-one should ever buy life insurance; the sum of market wide premiums is by definition more than the sum of any payments. So should everyone passively stop buying insurance, and actively self-insure through savings instead? Or are there other reasons - risk for example - which outweigh some pure economic drivers?
In our view, the FCA is right to focus on some components of active funds to drive greater competition. Given the nature of these funds (and assuming they are truly ‘active’), it may be right that investors pay a premium for investing. But it is also right that the FCA asks asset managers to focus on these fees again, ensuring that a fund is priced in relation to the cost of that fund.
In a similar vein, it is right that the FCA should consider focusing more closely on how ‘active’ a fund is. But the work needs to be carefully thought through: where a fund appears to be invested similarly to a benchmark then this could suggest the fund is a pseudo-passive fund. But equally the FCA should look at how long the fund has been invested in that way, the research carried out by the manager before investing and the wider governance and purpose to the holdings; we certainly shouldn't be pushing managers to alter portfolios merely to ‘prove’ their activity. The FCA’s work on governance should also help to address this.
Passive asset management is growing and rightly has a place in many portfolios due to the returns it can offer (measured against fees) as well as the overall market exposure investors can achieve. The FCA’s work in the active sector should be welcomed but with £6bn invested in expensive passive funds, the FCA should also focus on this area to ensure investors are not receiving the worst of all worlds - passive performance for active fees.
For our Asset Management market study interim report blog series visit: http://pwc.blogs.com/fsr