There's a 'revolution' coming to investing — and only the strong will survive

Bob Bryan

Sun, May 15, 2016, 5:04 AM

washington crossing the delaware american revolution

(Wikimedia Commons)
Washington Crossing the Delaware by Emanuel Leutze.

Revolutions don't usually end up working out for everyone involved.

When things get shaken up, whether politically, economically or technologically, there's eventually going to be a loser.

We're currently seeing online shopping ravaging department stores; travel agents are quickly disappearing in favor of online booking sites, and of course the British probably didn't feel great about what happened in the colonies in the late 1700s.

According to Andrew Ang, head of factor investing at BlackRock, that's exactly what's going on right now in the investing industry.

In Ang's opinion, the development of custom, factor-tailored products is going to usher in a whole different age of investing.

"This is the next revolution in asset management," Ang told Business Insider at a recent BlackRock roundtable.

Ang was talking about smart beta ETFs specifically, but also the idea of investing in a particular idea in a safer way. These are types of ETFs, or exchange traded funds, that allow investors to expose themselves to a particular idea that may perform better than the index as a whole, but with lower volatility or concern than simply buying a stock.

For instance, if an investor felt particularly good about emerging market's growth outlook, BlackRock offers the iShares Edge MSCI Multifactor Emerging Markets ETF. By tilting the investment toward emerging markets, this allows investors to get higher returns in the event that these markets go up more than the rest of the world, thus outperforming an ETF that is more proportionally weighted.

ETFs are also attractive, because, as we've noted, they have much lower fees for investors.

Why do they matter?

While these smart beta ETFs and factor-based products are interesting, they're really just another part of a larger trend in the investing world.

Investors are waking up to the startling reality of just how much fees affect performance. As we've noted in the past, fees can even make portfolios underperform the market, and when added up, 401(k) fees can hit $100,000 by retirement.

The issue is that with returns so low, some investors needing to increase their returns in order to meet retirement benchmarks (or most likely young people who haven't saved enough) may not simply be able to index their way to retirement savings.

"This delivers a way for investors to try and get more equity exposure or higher returns," said Small. "The market return may not be enough for some people, and that's where these products come in."

To fill the void between these indexes and active managers, many asset managers such as BlackRock are beginning to roll out products to skirt the line between active, high-fee mutual funds and passive, low-cost index funds.

To be fair, part of this is a pitch from BlackRock for their new smart-beta products. And as another caveat, these particular products may not even be successful. They are, however, representative of a certain mindset of asset managers in offering differentiated products for investors concerned with returns and fees.

(Vanguard)

This raises the question of whether these new products will make active managers obsolete. Why pay someone higher fees to invest in certain ideas when you can do it at a lower cost point?

In Small's opinion, it's not that people will shift from active managers to these new products, but rather from single assets while keeping some of their money with active managers.

"A vast majority of households invested assets are still in single-name stocks and bonds," Small said. "If you go back to 1993, 81% of people's assets were in corporate equities or single bond. Now it's more like 61%."

Small also noted that ETFs have also increased in total asset holdings from 0% in 1993 to 8% to 9% today.

This doesn't mean a good number of active managers won't still be losers, said Small.

"With these products, sure, you're going to see some managers that can't outperform," said Small. "So you're only going to have those asset managers that can truly produce alpha, produce results for their clients stick around."

His colleague, Salim Ramji, head of US Wealth Advisory, agreed.

"This is certainly going to cannibalize from active managers — there's no doubt," said Ramji.

So with more options because of this "revolution," active managers have to truly make a difference, or in a game of winners and losers, they're going to end up on the wrong side of that line.

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