Weekly Commentary October 18, 2019
For the first time ever, assets in U.S. index-based equity mutual funds and ETFs have surpassed those in active funds. As of Aug. 31, 2019, passive U.S. stock funds hit $4.27 trillion in assets, eclipsing the $4.25 trillion in their active counterparts.1
Active funds are generally understood as having a manager or a team of managers make decisions based on research and analysis. Passive funds are funds that have no manager but are constructed using a set of predetermined quantitative rules. The distinction between active and passive has been blurred in recent years with many funds having elements of both in their strategies.
Passive funds got their start in the 1970s, but really took off in 2009 as the current bull market began.1 Many of the new funds that have come to the market in the last 10 years are passive in nature.
While index funds2 present a wealth of opportunities for the investing public, especially cost savings, it’s important that we step back and look at the repercussions of this industry shift.
Now, because cash flows are being dominated by indexing, many active managers feel they are forced to incorporate the positions held by passive funds into their strategies so they don’t fall behind in performance. In turn, this has caused a huge focus on the largest 50 companies in the U.S.3 As these companies get larger, passive investors are required to buy more stock in them.
While the “big get bigger,” however, many areas of the market are being excluded. International assets and value stocks are examples of strategies that have underperformed during this period of passive acceleration.
As investors, it’s important that we constantly look for areas of opportunity in the market and refrain from putting all our focus on a single market-capitalization strategy. History has shown that while these trends may continue for some time, markets don’t move in a singular direction for long. A great example of this was the “Nifty-50” stocks4 in the 1970s that dominated returns in the market, until they didn’t.
At Exencial, we see value in passive investing, but also believe it’s still critical to remain diversified and include other strategies so that when passive, market-cap weighted strategies like the S&P 5005 falter – as they did in the early 2000s6 – we have exposure to other strategies they will behave differently. The 50 largest companies in the U.S. have done well recently, but these specific leaders are not representative of the entire market. There are several sectors (e.g., financials and energy) that haven’t participated in recent market growth to a large extent and yet shouldn’t be ignored.7
While the turning of the industry tide is not necessarily a bad thing, as investors we need to know that having some strategies that won’t behave just like the market-cap strategies can be a helpful way to invest.
Sources:
1. Bloomberg – End of era: Passive equity funds surpass active in epic shift
2. Investopedia – Index fund
3. Forbes – America’s largest public companies in 2019
4. Forbes – Are any of the ‘Nifty 50’ stocks still nifty?
5. Yahoo! Finance – S&P 500
6. Investopedia – The Great Recession
7. Forbes – The energy sector lagged in the third quarter
PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE RETURNS. Information and opinions provided herein reflect the views of the author as of the publication date of this article. Such views and opinions are subject to change at any point and without notice. Some of the information provided herein was obtained from third-party sources believed to be reliable but such information is not guaranteed to be accurate. In addition, the links provided within are for convenience only and the provision of the links does not imply any sponsorship, endorsement, or approval of any of the content. We do not guarantee the content or its accuracy and completeness. The content is being provided for informational purposes only, and nothing within is, or is intended to constitute, investment, tax, or legal advice or a recommendation to buy or sell any types of securities or investments. The author has not taken into account the investment objectives, financial situation, or particular needs of any individual investor. Any forward-looking statements or forecasts are based on assumptions only, and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. Any assumptions and projections displayed are estimates, hypothetical in nature, and meant to serve solely as a guideline. No investment decision should be made based solely on any information provided herein and the author is not responsible for the consequences of any decisions or actions taken as a result of information provided in this book. There is a risk of loss from an investment in securities, including the risk of total loss of principal, which an investor will need to be prepared to bear. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular investor’s financial situation or risk tolerance. Exencial Wealth Advisors, LLC (“EWA”) is an investment adviser registered with the Securities & Exchange Commission (SEC). However, such registration does not imply a certain level of skill or training and no inference to the contrary should be made. EWA may only transact business in those states in which it is registered, notice filed, or qualifies for an exemption or exclusion from registration or notice filing requirements. Complete information about our services and fees is contained in our Form ADV Part 2A (Disclosure Brochure), a copy of which can be obtained at www.adviserinfo.sec.gov or by calling us at 888-478-1971.