Financial services and asset management firm BlackRock has just announced a major change within its actively managed equity services. It plans to shift from some of its actively managed funds to more computerised/quantitative methods of investing, which will result in what insiders say are 40 jobs being lost within its actively managed fund division, including the dismissal of a few portfolio managers.
Additionally, as BlackRock attempts to retain its investors by cutting management fees, this will result in $30m lost in annual revenues and record an additional $25 million expenses from the compensation of the departing employees.
Despite the immediate drawbacks, BlackRock hopes that this decision will benefit them in the long term, and that lowered management fees will result in a smaller number of investors pulling their money from the funds. Having recently launched their BlackRock Advantage group, they hope that more quantitative methods of investing will result in greater returns at a lower cost to their investors.
This major decision by the world’s largest fund management firm reflects an overall shift in the world of investment management, from active to passive investing.
Active Fund Management vs Passive Fund Management
Active investing involves the investor placing his or her money into a mutual fund where the decisions as to which assets belong in the portfolio are determined by a human being, who relies on financial analysis, market trends and experience in order to do so. The portfolio manager attempts to ‘beat the market’ – usually measured against the S&P 500 – by purchasing stocks that are undervalued by the market and short-selling those which are overvalued.
Passive investing relies on the idea that it is very difficult for even experienced investors to consistently beat the market. The efficient markets hypothesis predicts that while some investors may occasionally beat the market, stocks are more often than not accurately priced. A passive investor would either rely on index funds, which would replicate exchange-based funds such as the S&P 500 by containing every stock in it, or ETFs, which are mutual funds that trade on exchanges, similar to the way a stock would. Typically, these have lower fees than are found in active fund management, and can result in less risk, as performance more closely mirrors the performance of the market.
There are pros and cons of both methods. Some feel that active fund management is a dying industry. This is backed by research that professional portfolio managers beat the market less than half of the time. Some studies suggest that managers beat benchmarks at an even smaller rate, closer to 20-30%.
However, many argue that the active management industry could perform very well in the next few years as governments relax some of the regulations that currently surround the active management industry. They also suggest that active management is far more successful in beating benchmarks than is commonly suggested.
According to an Invesco research report that spanned 20 years of data, the results were that active management has a history of beating investor benchmarks in many different metrics – for example, excess and risk-adjusted returns. The benefits aren’t exclusive to small cap firms and emerging markets. Rather, distinct periods of historical outperformance can be seen in US large caps, which have been portrayed as an asset class that is better accessed through traditional benchmark-tracking strategies.
Is Passive Management the Future?
BlackRock’s actively-managed equity funds have struggled with performance over the past few years which have led to a series of withdrawals by investors. This resulted in the decision to bring in the former head of Canada’s largest public pension fund, Mark Wiseman, who was able to revamp the pension fund’s operations by utilising technological and data-based techniques.
At the end of the day, actively managed funds are a $10trn industry, and while passive investing has risen in popularity in the past few years, active management isn’t going away any time soon. The future of active management is uncertain, but most experts agree that eventually the industry will find a middle ground between active and passive investing. Actively managed funds could potentially merge with each other to become larger funds. If this would happen investors could benefit from economies of scale by seeing lowered management fees. Ultimately, whether this is another signal towards the end of active management or if it simply signals a change within the industry remains to be seen.