Active vs Passive Investing: The Trillion Dollar Switch

Over $2.5 trillion has been switched from actively managed to index-tracking funds.  What does this mean for providers?

Active vs Passive Investing: the switch from active to index investing

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The trillion dollar switch

When I first saw this chart from the ICI Factbook in 2015, charting the cumulative switch from active funds to index funds.  I called it the “trillion dollar switch”.
 
I reinforced my call – first made to active managers in 2012 in this article for CFA Magazine – to decide whether they wanted to be “component manufacturers” and face commoditisation, or multi-asset “solutions providers.”
 
Almost 10 years on and the chart has extended the same trends – and it’s now the $2.5 trillion dollar switch!

Passive investing and index investing are different

​Important to note that the rise of index investing is not about “passive”.  In our view, there is no such thing as passive.  Indices are no longer just traditional passive “market cap weighted”.
 
Indices can be equal weighted, dividend weighted, factor-tilted, factor-isolated, sector-focused.  Index investing means using indices to design in or design out specific biases.  Each of these indices requires active choices in their design and methodology.  Furthermore, selecting an index exposure to implement within a portfolio requires an active choice.  So the rise of index investing is NOT the rise of passive.  It’s the rise of efficiency.

ETF does not means passive

​The original actively managed “exchange traded” fund is the Investment Trust (in closed ended form) launched in the UK in 1868.  The first open-ended ETF in its modern incarnation was in 1990.  Since then ETFs have been near synonymous with index investing.  But ETFs are a fund format, not an investment strategy.  The recent rise of actively managed ETFs help reinforce that distinction.

From a UK perspective

​We are delighted to have seen some of the UK fund houses embrace this structural rise of index investing (sometimes alongside an active offering).  Firms like HSBC Asset Management and Legal & General Investment Management (LGIM) even Aberdeen.  Their efforts have been rewarded by backing this structural trend.
 
Unfortunately, some UK fund houses that treat the active vs index debate more as one of religion, rather than reason.  The the reality is there’s room for both active and index-tracking investment styles.  In fact, they need each other to function well.  So there’s nothing wrong with offering both. 

Conclusion

​We welcome future innovation in the index investing space and in the efficiency of the ETF format. It’s up to fund provides to rise to that challenge.