Financial newspapers have understandably latched on to a recent report by S&P Dow Jones Indices’ Angana Jacob’s who suggested that large asset managers could well use zero-fee passive funds as a “loss leader” to retain their scale.
It’s an alluring argument, one indeed which has been circulating among industry thinkers for some time.
In a world where ‘disruptive’ business models and first-mover advantage are so keenly sought, cutting out fees entirely could conversely be a very profitable move for any firm that can subsequently retain clients through other means.
However, reading further into Jacob’s report creates more questions as it does answers.
"In a world where ‘disruptive’ business models and first-mover advantage are so keenly sought, cutting out fees entirely could conversely be a very profitable move"
In her talk of the “hollowing out” of active management, one suggestion is that active funds can retain fees by moving toward unconstrained investing or adding derivatives, leverage and shorts to their mandate.
“Divergence and clear positioning away from traditional broad beta mandates is already underway, but traditional active managers and alternatives will converge to some extent in unconstrained mandates or as suppliers of multi-asset solutions,” she says.
The rise of more multi-faceted and sophisticated investments is nothing new; the growth of absolute return is testament to this.
But can all fund groups honestly say they are innovating for the genuine benefit of their clients or, with higher fees, are they simply launching more baffling ‘me too’ products to boost their profits?
Jacob also questions the “strained” terminology of passive investing, complicated by the development of smart beta funds.
“The term ‘passive’, which denotes ‘passively managed’, could cover an index that is anything but passive in its complexity and ability to take risk; similarly ‘beta’ returns could be far from representative of the broad market,” the report states.
Later, she explains: “Just as difficult as it was to choose the right manager in the quest for superior risk-adjusted returns, it is now becoming difficult to select the right systematic strategy, given the explosion of product choice.
“Even something as simple as defining a factor, say value, can be done in a number of ways—book value, earnings, cash flow, or a combination of these…. different design choices in factor building, especially on the more complex end of the spectrum, can result in different exposures and, ultimately, returns.”
Over-complexity is something the funds industry has been battling with for some time. As we all know well, the majority of fund managers do not beat their benchmarks, but is the creation of ever more opaque strategies helping or hindering the cause?