When Warren Buffett revealed in 2014 that he had advised his wife to invest in a low-cost index fund rather than bother with stock pickers after his death, it seemed to signal the final nail in the coffin for active asset management.
In a characteristically frank letter to shareholders, the famed investment manager, who made his name as a stock picker, argued active management was rarely worth the money. “[The] long-term results from this policy [of investing in index funds] will be superior to those attained by most investors — whether pension funds, institutions or individuals — who employ high-fee managers,” he said.
In the years since, fund managers attempting to beat the market have swiftly lost ground to lower-cost funds that track an index, as disillusioned investors shunned stock pickers over concerns about overcharging and underperformance.
Assets managed in passive mutual funds grew 4.5 times faster than active in 2016 to reach $6.7tn, according to figures from Morningstar, the data provider.
On the back of this rapid growth, Moody’s, the rating agency, predicted in February that passive would overtake active management by 2024 in the US at the latest, controlling half the market, up from 28.5 per cent today.
But in the months since that Moody’s forecast, the active management industry appears to have staged a turnround, closing the gap on the passive industry’s rapid growth. Passive funds attracted 1.4 times the level of new cash as active funds for the six months to the end of June, at $509bn compared with $369bn.
That is in stark contrast to 2016, when passive funds attracted 5.1 times more new cash than active, according to Morningstar.
“Active managers seem to be mounting a counterattack, particularly in the US,” says Jose Garcia-Zarate, associate director of passive strategies research at Morningstar.
The question is whether active managers can maintain this momentum.
Mike O’Brien, chief executive for Europe, the Middle East and Africa at JPMorgan Asset Management, the bank-owned fund house that runs $1.87tn, believes that conditions are ripe for active managers to succeed over the next few years — and attract new money.
“Active management has had a big shakedown post financial crisis, with clients voting with their feet. There has been a challenge to the industry,” he said. “But now [market conditions mean] active management should outperform.”
According to Mr O’Brien, active managers struggled to beat the index in the bull market that followed the financial crisis. But with question marks looming over whether stock markets can continue to rise, particularly in the US, there is an opportunity for active managers to find the best companies and showcase their skills, he says.
Katia Coudray, chief executive of Syz Asset Management, the €16.1bn fund arm of the Swiss bank, agrees that passive management “has been driven by a rising bull market from the beginning of 2009”.
“Unfortunately for investors, stock markets do not go up in straight lines forever, and we could see rotations hurting index performance,” she says.
Dan Brocklebank, head of Orbis Investments UK, the boutique fund house, adds: “Passive funds will go down by the full market extent if there is a market downturn in the next three to five years. But active funds, at least some, should be able to navigate it better.”
The active fund industry has also been helped this year by strong inflows into fixed-income products. Actively managed bond funds attracted the lion’s share of fixed-income cash, at $292bn compared with $145bn for passive, during the first six months of 2017.
In 2016, passively managed fixed-income funds drew in $196bn, compared with $180bn in actively managed bond mutual funds.
Mr O’Brien says that as central banks move to unwind their quantitative easing programmes, some investors want fixed-income portfolios to be actively managed.
Mr Garcia-Zarate adds: “When it comes to fixed income, active funds still have a bit of an edge. Compared with equity, fixed income is an area where active managers find it easier to defend their work.”
There are also signs that advisers are moving less cash from active to passive funds than previously.
According to a survey of 33 financial advisers by Credit Suisse, the investment bank, new client money is 48 per cent active, 42 per cent passive and 10 per cent alternative.
“Unless the new money mix shifts significantly higher to passive over the next six months, we think this is another indication that the active-to-passive rotation could slow in the US in 2018,” analysts at Credit Suisse wrote.
Mr Garcia-Zarate says that a “great deal of the money” has already switched from simple actively managed funds to passive in recent years, which could help slow down the growth of index funds in future.
“The growth of passives is certainly driven by cost, but not all active managers are bad at what they do, and so if the money that switched in previous years into passive was mostly from underperforming active managers, then increasingly one is left with a cohort of, let’s call it good, active funds for which investors are willing to pay the fees,” he says.
But Stephen Tu, an analyst at Moody’s, says that even if the active fund industry shows signs of recovery this year, the overall outlook is the same: active management is losing ground to passive.
“That gap [between passive funds attracting more new money than active management] could narrow or increase at times, but overall we feel that gap is going to be there.
“And that gap will continue to grow and eventually passive will pass the level of active management,” he says.
Mr Garcia-Zarate also believes it is unlikely that the rapid growth of the passive industry is coming to an end.
“The passive fund industry has become really innovative, and so I would expect many things in product development on the passive side in years to come — particularly in non-plain vanilla exposures.
“This will continue to create challenges to the active side of the investment fund industry,” he says.
Active funds could also struggle to shrug off their image as an industry that charges high fees for disappointing performance.
Research has found that active fund managers fail to outperform their index, and regulators have expressed concerns that active managers are charging high fees for active funds that do little more than track an index.
As for Mr Buffett, a decade ago he bet $500,000 that an S&P500 index fund with low fees would generate better returns over 10 years than a portfolio of hedge funds — a bet he looks set to win easily this year.
In his annual letter to investors this year, the Berkshire Hathaway chief executive wrote to investors considering active investing: “The problem simply is that the great majority of managers who attempt to over-perform will fail.”