As hedge funds arguably best embody the spirit of active management you know it’s a watershed moment when “exchange-traded funds, which are the primary vehicle for passive management, now have assets under management greater than hedge funds, according to a count from research firm ETFGI.” Industry-wide, it has been observed that “growth in ETF assets continues to outpace assets under management (AuM) expansion in the wider asset management industry.” So while the active versus passive debate is often positioned as on-going, one could argue that it’s over (or ending very soon). Passive has won (or is winning). The game of thrones is over; house passive sits triumphant on the iron throne.
Thus one would think that we have arrived at a moment where believers in passive investing should celebrate. Not unlike the legions of undead preparing to attack the wall a rude awakening is upon us. A bifurcation is occurring in the ETF industry, and it has a direct impact on the passive versus active debate, because to date, ETFs have been the primary vehicle for executing a passive strategy. “In early November 2014, the SEC approved another version of non-transparent active investment product called exchange-traded managed funds (ETMFs). The SEC approval of ETMFs and potentially other requests for non-transparent active ETFs could lead to another phase of growth and innovation for ETFs in the U.S.” So while the index based ETF industry has been growing and fueling victory for the passive vs. active debate “traditional fund providers are taking action, creating ETF teams of their own as a precursor for potential future launches.” In other words, in the future hordes of active mutual fund companies may raise their dying products from the dead in the body of “ETFs”.
With active ETFs, ETMFs, and “ETFs” tracking indices by providers you’ve never heard of and “ETFs” with indices calculated by smaller players who may or may not be here tomorrow, it’s getting scary out there for anyone seeking to gain some type of reliable beta exposure. On the other hand, “the vast majority (approximately 99%) of U.S. ETF assets are currently in passively managed index products. Active ETFs accumulated approximately $16 billion assets under management (AUM) between 2008 and mid-2014.” So breathe easy right? No because winter is coming, change is upon us. However as I referenced in an earlier blog, there is a way to know if your ETF is truly passive and it will be more important than ever to use that formulaic approach to see what’s actually under the hood of an “ETF”.