Arguing for and against active over passive management is overly simplifying asset allocation and putting investors at risk, says Carol Geremia, the head of US$500 billion ($676 billion) global funds manager MFS.
“We’ve got to stop having the active v passive debate, especially at this stage of the cycle,” Geremia told a room of investors and financial services providers at the Financial Services Council Summit in Melbourne.
Investors are going into passive funds late in the investment cycle, which is the wrong time, she said.
They’re also doing it for the wrong reasons – to save money on fees and because they’re reducing their timeframe for generating a market return – Geremia said, in a panel discussion that included Nikko Asset Management’s Takumi Shibata, Mirae Asset Daewoo’s Peter Kim, Schroders’ Greg Cooper and AMP Capital’s Shane Oliver.
“Passive has become the default place for people to go looking for market exposure,” Geremia commented.
On the other hand, people look at active management as if it’s all the same, she said.
“But not all active management is created equal.”
The conversation relating to alpha and active management needs to advance to whether you are prepared to pay an illiquidity premium on the one hand, or whether you know someone can outperform the market on the other. Geremia refers to the latter as “liquid alpha”.
“As investors, we have to focus on what really matters, which is protecting liquid alpha as an industry and the importance of that,” she said.
The days of making returns simply by investing in passive funds will soon come to an end, Mirae Asset’s Kim added.
How did we get here?
Thirty years of grinding down to low interest rates has rewarded inefficient companies and it has rewarded mechanisms such as exchange-traded funds (ETFs), Kim said.
“If you’re buying passive funds, you’re buying whatever is in the index,” Kim explained. “There’s nothing that distinguishes good companies from the bad and, at this part of the cycle, bad companies get rewarded more because they don’t answer to market discipline. Now we are seeing higher interest rates; when higher rates do their thing, it will start to punish the weaker companies. Active managers will come back.”
Listed technology companies, in the US in particular, are where passive funds have their largest exposures, AMP Capital’s Oliver outlined.
“Last time I recall so much interest in passive funds was in 1999, and it does worry me the same thing is happening again,” he said. “IT stocks have been going higher and higher, meanwhile value-based active managers have been underperforming, relative to the overall market. Passive funds have the high-risk exposure to tech stocks.
“Unfortunately, all those investors who have piled into S&P 500 ETFs will find themselves massively overweight in the sector that has massively over-performed and is massively overvalued…I don’t know if we are there yet or what will end up happening but, eventually, everyone will look around and say, ‘How did we get here?’ ”
