Dec 16

Fee for service responsible for increased passive investment???

A change in adviser remuneration structure is causing a structural shift in asset allocation away from active products towards more passive products such as exchange traded funds (ETFs) and passive funds, according to Fidelity Investment Managers.

The above paragraph, taken from Money Management’s daily,  isn’t quite true. Whilst I believe adviser remuneration restructure has some impact on the move towards passive products, the big move to passive management really accelerated after investors and advisers saw that many active managers (including hedge funds) didn’t quite deliver their marketing hype during the negative return periods of the GFC. These large negative market returns frightened investors who demanded increased transparency, simplicity, and definitely at a reasonable cost…passively managed strategies tick all of these boxes and whilst some Morningstar and Mercer performance tables show a comeback of the active manager the damage was done and the psychology has changed from chasing return to reducing risk. 

I have a belief that, in general, investors and advisers felt their payments for alpha (active) risk would somehow reduce a portfolio’s beta (market) risk…alpha and beta risks are independent or uncorrelated so if the market goes down a lot then every long only fund goes down a lot…the impact of active management for the long only portfolio has a relatively small impact in big market downturns. So advisers and investors have simply decided to de-risk their portfolio by removing their portfolio’s only reducible risk…the alpha risk….and they just happen to save fees at the same time which is always an easier sell for an adviser. In fact, the reality is that the retail investor not only reduced their exposure to alpha risk but also beta risk as the proportion of cash or term deposits held by investors has possibly never been higher.

The GFC has changed the way everyone looks at risk and we are all a little more conservative and wary today.

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