In his seminal 1973 work, A Random Walk Down Wall Street, Princeton professor Burton Malkiel famously conducted a simulation that criticised some of the underlying assumptions of the entire business of professional investment management.
“A blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by experts,” Professor Malkiel concluded.
The hypothesis, and experiments that led to it, began a process of introspection that saw many in academia and financial services question whether the value being presented by investment managers (and fees being charged by them) was justified.
The suggestion that monkeys are just as well-equipped as professionals to add value was a direct challenge to the active management sector.
Jump forward several decades and a number of other decorated economists, psychologists and commentators have further propagated the idea that the concept of active management and expertise-based investment is flawed.
Most notably among those in recent times has been Nobel Prize winner Daniel Kahneman.
“People who spend their time, and earn their living, studying a particular topic produce poorer predictions than dart-throwing monkeys who would have distributed their choices evenly over the options,” Dr Kahneman wrote in Thinking Fast and Slow.
Consumer scepticism about the financial services industry has snowballed since the financial crisis of 2008-09, and the broader distrust in institutions that saw Donald Trump elected only added fuel to the fire.
All of this has contributed to a growing perception that funds management (and active management in particular) should be viewed with caution at best or as a downright manipulation of consumers at worst.
Unfortunately for the many talented and hardworking investment professionals out there, this view that the game is rigged is now in vogue and we have seen this infiltrate politics on both sides of the electoral divide.
Given the sentiment among consumers and in the ivory tower, the manufacturers behind passive investment-backed and index-hugging products have been quick to capitalise.
The major exchange-traded fund providers, for example, have made valiant strides in not only effectively distributing their product but in distributing their underlying investment philosophy.
First emerging in the '80s, ETFs gained momentum slowly in the US market but gained considerable steam in the wake of the GFC, with more than 1,500 products in operation and US$2 trillion in funds under management by the beginning of 2016 – indicating greater FUM than the entire Australian superannuation system.
Meanwhile down under, the ETF market grew from $17.8 billion to $21.3 billion over the course of 2016, according to research released by robo-adviser Stockspot.
But while the numbers indicate considerable growth, the psychological fight that goes alongside the take-up rate is equally significant.
Not a day goes by that we don’t hear an adviser extolling the benefits of low-cost passive investment products, pointing to benefits for their own business as well as the client’s portfolio and wallet.
In the US this has gone even further, with the emergence of a movement within the American financial advice industry made up of so-called ETF investment strategists.
During my travels in the US over the past two years as contributing editor, I came across many of these ETF investment strategists and other advisers who told me plainly they had gone “passive only”.
“No way am I letting all the money flow to a doggone active manager when I could let the client keep it and the game is rigged anyway,” a particularly animated Texan investment adviser told me at a conference.
Needless to say, this is a problem for active managers and their distribution colleagues if a portion of the intermediary market is not even considering their products on grounds of principle.
But there are some activities open to them to counteract the trend, if they are open to taking a page from the passive playbook.
While investment philosophy and the ‘anti-alpha’ ideology has played a role in the development of this ‘passive-only’ niche community of advisers, other factors have also come into play.
In terms of their marketing strategy, the ETF providers in the US have been very successful in demonstrating their support of the adviser market, and independents in general.
They have done this by actively engaging in debates not only about investment, but about regulation and business models and industry politics.
They have also launched considerable practice management capabilities, sending an army of expert consultants into practices across the land to help advisers grow, thereby demonstrating their commitment to the cause.
These activities are smart and active managers and marketers could consider doing more to demonstrate not only their expertise and prowess, but also their political positioning in the market and support for intermediary businesses.
Outperforming the market matters, but advisers want to hear from active managers even in the downtimes. Let the battle of ideas commence.
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