Actively vs Passively Managed Funds
Suzanne Duncan of IBM, in a recent conference predicted that institutional assets will shift over the next decade from 90% actively managed to 90% passively managed [via Integrity Research].
There is no question in my mind that the share of equity assets will shift towards passively managed funds. But I can’t agree that the shift will be as dramatic as that. Passive and actively managed strategies don’t just compete with each other for market share. They also affect each other’s success. Here’s how.
A market that is dominated by active strategies, makes it very difficult for these competing active strategies to make money, especially compared to the broad market. In such a market, the lower costs of passively managed funds can make them attractive. That’s the kind of market we have right now.
On the other hand if we have a market where passive investing dominates completely, it should be easier for a few active strategies to make money because there are very few people actively interpreting new information to assess its impact on companies.
In effect, there should be a stable state in the market where the share of active funds is not so large that they all compete away their informational advantage over passive strategies to an extent that they can’t justify their fees. This thesis borrows loosely from the work of biologist Maynard Smith who applied this to evolutionary theory. Of course, this won’t help us predict what the share of each strategy is in the theoretical stable state, but my hunch is that it is not close to either 90/10 or 10/90.