Last year saw the continuation of a trend that has gained significant momentum over the past decade as another flood of investor cash drained out of actively-managed funds and into their passively managed counterparts.
Yet the year also saw seismic political changes, prompting some to suggest that heightened political instability in the West, as well as the move away from aggressive quantitative easing by central banks, will feed through into more volatility and differentiation between stock movements. Therein providing a fertile backdrop for active managers to demonstrate their value.
Recent research from Bank of America Merrill Lynch (BAML) looking at U.S. fund returns since 1991 provides some support for this. It shows better fund returns when S&P 500 stocks moved in a less correlated fashion, as well as when the performance difference between the best and worst performing spreads was greater.
The post-financial crisis years have been unhelpful for U.S. fund managers insofar as correlations have been high and differentiation between the top and bottom performing stocks has been low, largely due to the precedence accorded to central bank interventions and macro concerns over individual stock factors.
However, BAML promptly delivers some qualifiers. Firstly, the research team says it has found no evidence that volatility helps fund managers to outperform. Secondly, it cites "virtually no relationship" between the level of interest rates and the success achieved by active managers.
Taking a step back and looking at the broader backdrop faced by active managers today, it is clear that challenges to the industry has mounted over recent decades and show little sign of diminishing.
To begin with the investor bugbear of fees, it is increasingly difficult for active managers to compete with passive managers whose operating expenses are dramatically lower. Futhermore, index funds function as economies of scale, enabling cost savings to be secured as more funds are won. This is amply demonstrated by the price war taking place in exchange-traded funds (ETFs), with market leaders Vanguard and BlackRock both slicing fees again in December, once more upping their value proposition.
This price war, which has also dragged in active managers whose average fees continue to decline, comes against an increasingly expensive reality characterized by burdensome costs for managers to keep up with the latest technology and regulations, and which pummels smaller fund managers the most aggressively.
Meanwhile, competition levels within the fund management industry have erupted. Consider the widespread availability and instantaneous dissemination of information and research, the sheer number of people working in financial services, the greatly increased share of the market dominated by institutional investors and the dramatically increased intensity of trading volumes today.