LONDON – The debate between active and passive investing has been ongoing for over two decades now with researchers trying to determine which of the two investing styles is better. Although most results are not fully conclusive, passive investing seems to be winning in terms of assets under management (AUM).
The chart below, published by ETFGI, illustrates the rapid growth of passive products in the last 20 years. Although hedge funds are only a subset of the active manager universe, we use this illustration primarily to highlight how quickly passive investing has grown in the last two decades.
At the end of the second quarter 2015, the AUM of exchange traded funds (ETFs) and exchange traded products (ETPs) on a global scale rose to nearly $3 trillion and surpassed that of hedge funds for the first time in history.
So why is money flowing into these passive products?
To answer this question we ran a simple analysis, in which we compared the performance of all funds which make up the Investment Association's (IA) Flexible investment Sector to the FTSE All Share Index between January 2006 and September 2015. The results were not surprising and were very much in line with the existing research.
We found that active fund managers on average outperformed their benchmark on a gross level (before commissions and fees) by approximately 1 percent, showing that they possess some skill. However they have underperformed the FTSE UK All Share index after the deduction of fees and expenses by around 0.6 percent. This indicates that the primary drag on performance of active fund managers is cost.
Higher Fees: Worth The Cost?
So why do active managers have such high costs?