Passive Investing vs. Active Investing: Where Are the Investors Leaning?

There are generally two types of investors when it comes to the world of business. On one side, you have the passive investors who aim to build their wealth gradually. These investors buy securities for the long haul and do not seek to profit from market timing and short-term price fluctuations.

On the other, you have the active investors who take a relatively higher degree of risk in an attempt to maximize returns. Instead of focusing on the safety of principal or income, they emphasize capital appreciation as their primary investment goal.

One of the few heated debates within investment circles is whether one is better than the other. Advocates of both sides are putting forward arguments and statistics to support their views. Our question is: which side are the investors leaning?

The Barbell Hypothesis

Huw van Steenis, a senior adviser to the Governor of the Bank of England, hypothesized that investor flows would polarize into the shape of a barbell. On one end, you have investors flocking to exchange-traded funds (ETFs) and passive funds to conveniently and affordably access benchmark returns. On the other, you have investors allocating more of their money to specialist fund managers who place the money in real estate, hedge funds, private equity, and the like to obtain higher returns.

A Lopsided Barbell

After van Steenis announced his hypothesis 15 years ago, he found how lopsided the investment barbell had become. While investors have moved nearly $3 trillion into index funds and ETFs globally, people actually make real money on the active side. According to research by the Boston Consulting Group, alternative asset managers received 43 percent of the management fees in the investment industry in 2017, an increase of 14% from 2003.

Another thing that van Steenis noticed is that active investors still paid nearly the same amount of fees as they did 15 years ago. Although technology has allowed investors to save billions through index funds, ETFs, and more affordable mutual funds, large investors have increased their fee budgets and risk on hedge funds, high-margin private equity, and other specialist fund managers.

What about the Other Side of the Barbell?

When you look at the other end of the barbell, you’ll find that one of the defining themes in asset management over the past decade is the rise of passive investing. According to a report by Blackrock, an American global investment management corporation, ETFs have soared 17-fold since 2003. This figure may double again over the coming four to eight years, the report says.

One of the reasons behind the increase in ETFs is the democratization of access to investing. Ordinary people are now able to save for their retirement in ways that were exclusively available to institutional managers before.

This good news, however, has not translated into the same level of success for investment firms. ETFs, unfortunately, represent only three percent of the industry fees paid to the firms.

Although investors are leaning toward active investing, van Steenis found that investment firms from both ends of the barbell are beginning to work together. According to research from Boston University, managers of index funds and ETFs are starting to vote more frequently with engaged and activist investors.


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