The debate over the merits of active versus passive asset management is an old one, and the Passives appear to be winning. The traditional fees-for-performance model of the fund management industry has seen an outflow of funds, while trackers, exchange-traded-funds and other passive vehicles have seen huge inflows.
New data released by ETFGI, a consultancy, shows that July this year saw net new assets of $41.3 billion flow into ETFs and other exchange-traded tracking products, the second largest ever monthly inflow. (The largest was January this year.) July marked 54 consecutive months of net growth in inflows.
There are now $5.12 trillion in exchange-traded passive assets in some 7,500 vehicles in 57 countries.
This huge growth has been matched by a collapse in confidence – and in assets allocated – to an asset class which, not long ago, was feted as the future of active asset management: Absolute Return.
Absolute Return funds aimed to use hedge fund-type tactics to deliver stable returns, and saw rapid growth following the financial crisis. The industry had, so went the marketing material, achieved the alchemy of being able to give investors low-risk returns through the smart and innovative use of high-risk strategies.
But sentiment has turned against the asset class, with large outflows around the world. One asset manager quoted by the Financial Times sums up the sentiment, saying: “Many of these funds are simply a marketing gimmick to enable inherently low return funds to be sold with inherently high fees.”
Investors seem to agree, with billions having been pulled from Absolute Return funds this year.
Does this mean that investors have entered a “Risk Off” mode?
Not entirely. Exchange-traded funds are not inherently low risk. Emerging markets, commodities, high yield debt and other riskier assets all have ETFs devoted to them, as well as S&P500, FTSE 100 and other blue chip, low-risk strategies. Instead, what has changed is the price that investors are willing to pay for third party managers.
In part, this is a function of the non-stop bull markets we have seen since the financial crisis - why pay a manager when a tracker will show growth? – but also the move is a sign of a fundamental shift in investor behaviour which will have an impact on GCC markets.
Funds which track benchmark indices are low-cost and increasingly popular, and the inclusion of Saudi Arabia and Kuwait in Emerging Market indices from 2019 – next to the UAE and Qatar – will add them to the range of choices available. Overnight, stocks trading on these markets will be targeted and tracked by billions of dollars in passive money. The key question is: Are we ready?
In all honesty, the answer is “no” for most companies.
While the GCC equity markets have been preparing themselves for inclusion in the EM indices, a fundamental change has been taking place in the investment world. The old certainties – active managers can out-perform the market, high fees are justified for the high reward they deliver, risk is a mathematical formula that can be beaten using hedging techniques – have fallen out of favour.
The new normal is that, in an uncertain world, it is unwise to add an extra layer of uncertainty by bringing in an active manager. Instead, follow the benchmark, track its ups and downs, and reap the rewards as sophisticated but automated strategies deliver growth. When risk appears, switch asset class, but still avoid the siren call of the active manager.
At the active end of the scale, meanwhile, value is delivered through ever-more esoteric asset classes: real estate, private equity, and litigation funds, for example.
In other words, the money that will be coming to GCC stocks next year is likely to be passive, but highly selective. Firms cannot take for granted that passives will be interested in them, regardless of their size and weighting. They will have to find new ways to appeal to international investors. Yet plenty of large Arab corporates are assuming that they will attract passive money – all they have to do is sit back and wait for it to arrive.
Unfortunately for them, passive funds may be cheap, but they are not indiscriminate. More and more passives are applying active-style rules and restrictions, and GCC firms that are complacent will miss out.
The arrival of passive funds to our markets may prove to be a blessing for some: wider share ownership, greater liquidity, higher valuation.
But it is highly likely it will become a curse for others.