The US$500 billion ($620 billion) that is leaving actively managed strategies each year is making it harder for active managers to outperform their benchmarks, says S&P Dow Jones Indices senior director Tim Edwards.
Speaking to InvestorDaily, Mr Edwards said active management is not a ‘zero-sum game’.
“For people operating in that market to outperform, they need someone to underperform. They can all get rich, but they can’t all outperform the market,” he said.
The problem for active managers, Mr Edwards said, is that much of the money currently piling into passive strategies belongs to relatively unsophisticated retail investors.
“These are retail investors who until recently were perhaps reading the Wall Street Journal and treating it like it was insider information. For active managers to outperform, they need someone to supply the alpha,” he said.
With the investors on the losing side of the trade calling it quits, active fund managers are left with a smaller pie of ‘alpha’ (or outperformance) to fight over, Mr Edwards said.
Mr Edwards recently spoke at a CFA Institute event where he compared current equities markets to those in 1960.
“In the 1960s, 91 per cent of trading was done by retail investors … Today, 95 per cent of trading is institutional,” he said.
“If you look at active management in these terms, it’s a ruthless Darwinian marketplace. If you lose your edge, people take money away from you. If you didn’t have an edge to start with, you don’t attract capital.
“On the investor side, it’s not the people who have a great experience in active management that are going passive – it’s the people who were until recently supplying that net alpha. So the more passive investors there are, the harder and harder it becomes for active managers to make money.”
