What’s the common theme linking the following: Fidelity’s recently announced plans to expand its US ETF range; BlackRock’s August application to the SEC to develop its own indices; MSCI’s launch of a new strategy index range; the lawsuit filed last week by Robert Arnott’s Research Affiliates against WisdomTree; a less-publicised spat between French research institute EDHEC Risk and Arnott over alternative index methodologies; and a reported move by “a cabal of active asset managers” to fight back against the growing uptake of passive funds?
All are signs of an intensifying fight over the middle ground of fund management, where active and passive strategies are increasingly converging. There’s a battle of the bulge, as it were.
The traditional passive fund management business—tracking indices like the S&P 500, MSCI World or MSCI Emerging Markets—is likely to be won by Vanguard, one head of a European ETF business told me this week. Noone else can really compete with that firm’s scale and low costs, he explained. For its part, Vanguard is sticking to the replication of large, liquid, capitalisation-weighted benchmarks, whether via ETFs or index funds, fitting the bill.
Everyone else—including other ETF providers and passive fund managers, active fund operators and now also index providers—is now involved in a scramble to establish competitive advantage in slightly higher-margin areas. The emphasis is on establishing and protecting intellectual capital, a tough job given the commoditisation of many parts of finance.
The rewards on offer are potentially huge. “This is the biggest inflection point in the fund management business since the 1970s,” the ETF head commented.
The battle of the bulge raises interesting questions about governance and fiduciary duties. Should index providers be involved in fund management? This is effectively what’s happening when you start introducing factor tilts and embedded strategies into benchmarks. Should a fund manager be creating its own benchmarks, given the importance of an independent measurement of performance?
These questions will be resolved in time. But for investors, dividing fund providers into “active” and “passive” no longer makes sense, if it ever did. As quantitative investment models proliferate, the emphasis will be on evaluating investment strategies in a holistic, understandable way—a tough task, given some of the complexities involved in fund and index design. There will be a need for a range of new fund comparison tools. And those answering to investors—fund board directors—will have a whole lot of extra homework to do.