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Sep 04

Active versus Passive net cash flow

I found the above chart in an article at marketwatch.com and it shows the net cash flows of both active and passive managed funds in the US over the last 10 years. As can be seen, whilst passive funds (or index funds) have had positive flows every single year, actively managed funds have had massive outflows the last four years and net outflows six out of the last ten. Now these numbers are distorted a little, in so far that actively managed funds manage many more assets than passive managers so proportionately the differences wouldn’t be as exaggerated.

Either way, this trend of moving from active to passive has occurred in Australia also. Particularly in recent years with the extreme volatility of equity markets. Retail investors and their advisers are abandoning actively managed funds in favour of passiveyl managed funds for three simple reasons…

  1. Simplicity…you know what you are going to get…the index minus some costs
  2. Transparent…there will be no hidden surprises thanks to bets gone wrong (think Challenger AUstralian equities and their bets on ABC Childcare and Babcock and Brown)…you know exactly where you are invested and in the case of the Australian equities you see the performance on the news every night
  3. Low cost…whilst I and many others believe it is possible to generate alpha, unfortunately managers find it very difficult to achieve alpha after their fees are taken out…this is particularly the case with bond funds

From an advisers perspective, using passive fund managers simply means the only concern is asset allocation and no action required should the key people leave the fund 452-style or the fund blows up performance-wise…increasingly advisers are realising this and they are focusing on their business and clients as opposed to wasting their time positioning themselves as investment experts.

With the expansion of exchange traded funds (ETFs) in Australia, and they are just index funds at this stage, and the MySuper recommendations from Jeremy Cooper, I can really only see massive growth for passively managed funds in Australia and significant funds outflow for the actively managed. This risk to massive flow to index managers is that prices can be inflated without consideration to value (tech boom to provide an exaggerated example and therefore providing opportunity for the active manager which is not a bad thing) but the chances of a bubble in equities in these risk averse times  appears a long way off.

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