Funds Europe – Given the perception that active managers can outperform in inefficient markets such as emerging markets or less analyst-covered small caps, is ETF product development in this area almost bound to fail?
Mahmood – The short answer is a resounding no. It’s not an active versus passive debate – it’s about what your time horizon is, what your preference is and what kind of overlay you prefer. Over the last 15-year period across all international equity categories, a large majority of active managers underperformed the respective benchmarks; 73% of international active small-cap funds underperformed, and in supposedly inefficient emerging markets, 94% of active funds underperformed. If you’re a long-term investor, then the long-term evidence of active managers speaks for itself.
For us, the ETF is a technology, or a wrapper, that can be used to deliver the active strategy too. It keeps the liquidity, transparency and the diversification – but the structure is ETF. You can use the best of both elements to provide individual investors with what they’re looking for.
Guthrie – Different investors use the toolset in different ways as well. If the fundamental thesis is that you’re either going to have an active manager or you’re doing something that’s purely passive, I think that’s probably not the way to look at it. Most large-scale investors have both, in fact the rise of smart beta means you don’t have to compromise on product development.
The only real free lunch in the investing world is diversification and low cost, and I think at the core of most people’s portfolios, even the active houses now, there is this idea of you still need to take this diversified exposure.
If you go back 20 years, most active managers closely followed benchmarks. The systematising of the index process, of being able to have transparent index tracking funds, took a lot of that away.
Baron – We have to remind ourselves that in some areas, ETFs are not always the recipe for liquidity as one must always consider the liquidity of the underlying market. And the more ETFs are being created, the more it will bring to light some areas of the market and the more it will bring investments to these areas; It can become this self-fulfilling prophecy where ETFs attract liquidity.
Although there are clients who still prefer only active or only passive, we see an increasing number of investors who want both tools.
We see, for example, investors with high convictions in a particular region selecting an actively managed mutual fund suiting their views but also involving ETFs, which can act as a liquidity buffer and enable them to have more flexibility in the portfolio. We have to see mutual funds, ETFs and other vehicles as a toolbox, which can be used together or separately, helping investors implement their views.
Shah – Active is a very important part of allocation, especially for those specialised asset classes. For EM and the small caps where stock-picking or individual bond picking becomes quite important based on fundamentals of companies; you cannot just go and use the broader benchmarks-linked ETF because you do not know what the underlying exposure is and you end up with unintended exposure. Again, there are a lot of benchmark developments going on, but that may not provide equally effective allocations. Having active liquidity and allocation monitoring can add value.
Guignard – We need to add the very important point of fees. The differences between active and passive are huge regarding the cost of management, and they matter a lot for both asset classes.
Regarding liquidity, ETFs have been a very important contributor to making emerging markets easier to access. If you remember, 15-20 years ago when ETFs were starting, emerging markets were very difficult and expensive to access, and pretty illiquid as well.
Garcia-Zarate – If your time horizon is very short, probably you’re better off in certain categories to go with an active fund, but once you get to ten years, the success ratio does drop dramatically and it’s a combination of the natural tendency of human beings to make mistakes, but also the maths of the compounding benefits of the low fees. Again, this is perpetuating the active versus passive debate, and I think we should move on and try to marry the two together and let people decide.
Finding an active manager that performs consistently over the long term is quite difficult, when you’ve got a number of passive funds that are charging very, very low fees. The power of low fees shouldn’t be underestimated – it’s a massive barrier for active managers over the long term.
Mahmood – When it comes to combining the two, combination strategies can work quite well. At Nutmeg, we have in the past invested in fixed income funds with an active overlay in terms of liquidity monitoring. Index selection also plays a role. As you can get indices where there will be a liquidity filter, there will be a quality filter – in particular in ESG indexes, you get that implicit within there. It doesn’t make the index unless it hits a high threshold of liquidity. There are plenty of indices out there that will have a cap on, for instance, country, region or sector – which can further constrain based on individual preferences.