Active fund managers have continued to face an uphill battle in attracting investor dollars, market commentators say.
Meanwhile, the market darlings of Australia’s burgeoning exchange-traded fund (ETF) industry, passive ETFs, have continued to draw investor attention thanks to their lower fees, greater transparency, built-in diversification and resilience across market cycles.
Notably, active ETFs represent some 20 per cent of total ETF assets locally and have accounted for just 2 per cent of net flows over the past 12 months.
Arian Neiron, managing director and CEO of VanEck Asia-Pacific, even suggested last month that the hard-won reputation of index ETFs, in general, has given active ETFs an “advantage they haven’t necessarily earned”.
But some active managers are pushing back, arguing there’s still a strong case for active strategies. One professional even claimed that index exposure “guarantees mediocrity”.
Speaking at the Australian Shareholders’ Association Conference last week, Andrew Coleman, co-founder at Teaminvest Private, conceded that the case for active management, on paper, can often appear to favour a passive approach.
“The data is actually that 97 per cent of day traders lose money – not even break even – lose money. Eighty per cent of active fund managers fail to beat the index before fees, let alone after fees. So that’s a pretty damning indictment of active management,” Coleman said.
“We have had roughly 53 years that the efficient markets hypothesis has told us, and continually been proven correct in academic research, that it’s impossible to pick winners. Let’s call them unicorns. They’re mythical, they don’t exist.
“So how is it that I can sit on the active side of that debate having just told you those stats? The problem is the other side of the debate, holding an index guarantees mediocrity.”
Coleman argued that index funds, while cost-effective, merely offer average outcomes – and for investors seeking meaningful wealth creation, passive strategies won’t deliver outperformance.
“If you want to grow faster than that, and you want to take advantage of the fact that in compounding, very small changes in percentages over a very long time results in very big differences in your dollar wealth, then you actually have to take an active strategy,” Coleman said.
“A passive strategy will guarantee you a return that is mediocre.”
Portfolio manager at Fidelity, Maroun Younes, also reminded attendees that passive managers don’t engage in price discovery.
“They’re not going out there researching companies, trying to find the best companies for you – it’s a very formulaic approach,” Younes said.
According to the investment analyst, passive managers are “buying what they’re told to buy”.
“So you end up buying companies that perhaps have quite a poor outlook for the future, but yet they have to buy 7 or 8 per cent of your capital into those companies. So they’re not really engaging in price discovery. They’re not trying to figure out or sift through and identify either the dogs or the winners or the unicorns.”
With roughly 30 per cent of both US and Australian indices driven by just a handful of stocks, Younes warned that investors’ fortunes are increasingly tethered to the performance of a narrow group of companies concentrated in only a few sectors.
“And if the tailwinds are good for them, as they have been for the past 10 years, or as they were for resources in Australia for a long time, then you do well. But if the outlook for those businesses or sectors isn’t great, then you’re not going to do so well.”
Passive v active to become a ‘cyclical’ debate
Tim Carleton, founder of Auscap Asset Management, said long-term equity returns are fundamentally driven by a company’s dividend yield and its earnings growth over time. While short-term market movements can create noise, he noted that over the long run, total returns are increasingly dictated by these two core factors.
Carleton explained that passive investing thrives when the largest companies in a market are also the fastest-growing, because market-cap-weighted indices naturally allocate more weight to those firms.
“If I was sitting here 10 years ago and said, ‘What’s the perfect situation for a passive strategy?’, I’d design an index on a group of, say, 500 companies where the very biggest companies are growing their earnings most quickly, because you’re naturally overweight those big companies, and you’re getting that at a very low fee. Surprise, surprise,” he said.
This has played out in recent years in indices like the S&P 500 and the Nasdaq, where companies such as those in the Magnificent Seven have delivered both outsized index weightings and robust earnings growth, bolstering the case for passive strategies.
However, Carleton argued that Australia’s equity market offers a very different landscape – one skewed towards “stodgy, old-generation, low-growth businesses” and more conducive to active management.
“We’ve got a 25 per cent representation by the big banks, right? And they have collectively not grown earnings for a decade, and as we sit here today, they’re trading on close to their most expensive multiple of earnings ever. For what we see is at best, anaemic growth,” he said.
He added that the broader index is further weighed down by exposure to commodity and energy companies, many of which are now on the wrong side of the China supercycle.
“So if I was going to design the perfect environment … for active investing, I’d have 40 per cent plus of my market in companies where I think the earnings are going to go flat to backwards, which is exactly what you’ve got in the domestic environment,” he said.
Looking ahead, Carleton believes the debate between passive and active management will be cyclical.
“I suspect we’ll be sitting here in 10 years’ time, and active managers will look like geniuses, and they won’t all be. They’ve just had a benchmark or a passive index that hasn’t grown earnings over time collectively, and they’ve been able to identify the businesses below those very largest businesses that have grown earnings at attractive rates over time,” he said.
