Passive turns Active

People start talking when a multi-decade trend starts reversing.

According to JP Morgan report, the average asset-weighted fee on ETFs, that had been in a decline over many years, has started to bottom out.

ETF fees are bottoming out, Source: JP Morgan

But what is it got to do with investing culture?

Culture has a big impact on the way you invest. A baby boomer looks at investing slightly differently. He’s probably been there in the inflationary periods of the 70’s, the oil crisis in the 90’s and the dotcom bust in the early 2000’s. He’s likely to be okay with the ‘hands-off’ approach to investing. Take lower risks and invest in funds or ETFs that track major indices.

A young millennial or a Gen-Z investor is likely to invest in a more ‘hands-on’ way. He wants to select his own set of investments. He doesn’t care much about the 60/40 equity-fixed income rule. He has the power of the internet at his disposal to look at what other people are saying about those investments. Its a different investing culture, which can bring about some major changes in the investment management landscape.

Passive turns Active

One of the most notable trends in this industry has been the way passive funds and products have eaten active investing’s lunch. It looked inevitable in hindsight too.

After years of underperformance (on average), blaming the Fed (for literally everything) and swimming against the passive tide, the debate seemed like over. Passive funds like ETFs are cheaper, transparent and very effective vehicles to get broad based exposure to different markets. Passive works!

What ensued was a price war. According to JP Morgan’s calculations, asset-weighted fees fell 43% to 19 basis points from 2012 to 2020. If cheaper is better, the one who can provide the least expensive access to different markets and can create the best distribution network, wins. This was based on the premise that if fees are trending lower, as long as you can keep adding AUM, a low single digit basis point fee would be enough to fund the growth of the business.

For context, Vanguard’s Total Stock Market index fund, with a fee of 4 basis points and AUM of $1.2 TRILLION, would generate revenues of $4.8bn, levels similar to UK’s Jupiter Fund Management.

Scale is crucial, but how do you get it?

Private market assets have ballooned over the last decade, with rates moving lower and liquidity spigots running at max velocity.

Asset managers have looked at private assets as a way to scale up. The fees is relatively higher and the funds have built-in lock-in periods. Higher fees and longer duration capital is very attractive and fits in perfectly.

Private market AUM, Source: Financial Times

As the new investing culture takes over, asset management firms have realised that they need to adapt to the investing tastes of today. By expanding horizontally into different product categories, they’ve included products with exposure to wider range of niche sectors and themes for a slightly higher fee.

Sustainable investing and ESG has become insanely popular, as I wrote here a few weeks ago. For a few extra basis points, you can invest in companies that are ‘doing good’.

Thematic ETFs have taken off too. These products allow you to invest in niche ideas, from electrical vehicles, to renewable energy, fintech, 5G and cybersecurity. How about the Goldman Sachs Future Planet Equity ETF, an active ETF that invests in companies addressing problems across the ESG spectrum? Or the Global Blockchain ETF, that invests in companies positioned to benefit from increased adoption of blockchain technologies.

Would you care paying a few extra basis points for a swath of new products? Likely not. Global thematic ETF AUM has tripled in the last three years to $595bn, according to Morningstar.

Active ETFs have made considerable strides recently. According to Trackinsight, net global inflows in Active ETFs increased by 15.5% in Q12021 vs a year ago, a majority of which were driven by new launches in the U.S.

Moving into private markets, active ETFs and thematic products allows asset managers to expand their investor base and capture a young investor cohort that is willing to pay a higher fee.

AUM for the passive industry have surged from $6tn in 2019 to more than $9tn this year. When inflows of this size are being directed towards high fee funds on the back of higher demand, the asset-weighted fee starts creeping up higher.

More consolidation and M&A in the investment management space looks likely from here. Global banks like J.P Morgan and Goldman Sachs are already pushing towards taking a larger share of the world’s investable savings. JPM’s recent acquisitions of OpenInvest (An EG investing platform), Nutmeg (a UK-based digital wealth management platform) and Campbell Global (a forest and timberland investing provider) is a prime example of that.

Funny how something very intangible like investing culture can drive very tangible changes in the investment industry.

Until next time,

The Atomic Investor

1 Comment

  1. niftyfifty1994 says:

    Such valuable information each time@ atomic investor
    Keep up the good informative work 👍


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