Posted by: Tom McKeon on October 9, 2017
...because active managers are pushing back with obfuscation, disinformation and half-truths.
Wellington Management—a venerable and well-established money manager—recently published a research report intended to make an argument in favor of active portfolio management. Of course they and their active management brethren have seen virtually all mutual fund industry asset flows going into the index-based Exchange Traded Fund (ETF) silo in recent years. That has come at the expense of active managers like Wellington.
Wellington’s report is titled: “An Index Isn’t a Fiduciary—and Six Other Concerns About the Push for Passive.” Understandably, the author—a fellow CFA Charterholder—tries to build a case for active management, because he works for a firm that manages portfolios actively. In this writer’s opinion, he falls short of his objective. Let’s look at the first argument.
An Index Is Not A Fiduciary
The author makes the argument that a fiduciary is a person or organization that has two key responsibilities with respect to its clients: a duty of care and a duty of loyalty to the client. That is fair enough, but can only come into play when manager and client have a direct relationship.
There was a time in the investment business—several decades ago—when institutional managers would create a mutual fund to accept small investments from friends and family who could not meet their large institutional minimum accounts. When that client could sit across a desk from the mutual fund manager, the manager arguably acted as a fiduciary taking the investors unique goals and objectives into account.
The mutual fund business has grown enormously over the past several decades and is now largely a distributed business: most investors access their mutual fund investments through intermediaries such as investment advisors, wealth managers, brokers or fund supermarkets like Schwab. The investor and the mutual fund manager never connect whatsoever.
The active mutual fund manager is a fiduciary only to the mandate of the fund she manages. She has no responsibility to the end investor in Peoria, Poughkeepsie or Phoenixville. She has no idea who the vast majority of fund shareholders are. You can’t be a fiduciary to someone you don’t know.
Similarly, the manager (or algorithm) of an ETF or mutual fund that passively tracks an index only has a duty to adhere to the fund’s mandate.
As such, the fiduciary duty to act in the client’s best interest is appropriately pushed down the food chain to the investment professional (advisor, wealth manager, broker) who actually interfaces with the client. It is their job to ascertain the client’s unique goals and objectives and recommend an appropriate mix of assets to achieve them.
Mutual funds have grown fabulously on this simple reality and the convenience of accessing multiple asset classes, managers and market exposures efficiently and cost-effectively. Clients can now have broadly diversified, globally allocated and balanced portfolios through the efficiency and scale of mutual funds.
Water Flows Downhill
The reason why ETFs are crushing the mutual fund competition is that advisor and investors alike are simply looking at the evidence and voting with their dollars. Industry-wide performance data show time and time again that actively managed mutual funds—with their fat expense ratios—do not earn their keep. That is they do not out perform their stated benchmark—net of fees—consistently or predictably. When investors and their advisors get tired of that compromised value proposition, they understandably look for superior products. Enter the Index-based ETF or mutual fund.
Index-based ETFs give investors the most direct path to capturing virtually all of a market’s return. And index-based fund are now much more than just market-cap weighted indexes. They now track a plethora of relevant market factors (value, growth, momentum, yield, etc.) giving investors many more ways to capture market returns and/or express an investment outlook.
Disruption Is An Equal-Opportunity Thing
The pain in active management-land is real and understandable. The disruption so many active managers love to expound as they search for the next Google or Amazon to invest in has landed on their own active-management investing model.
So while an index is not a fiduciary (to the private client in Peoria)—neither is an active portfolio manager that manages a fund in Manhattan a fiduciary to that same client. So Wellington has published a report that leads off with a bit of clever obfuscation. Their pain is real—and it’s not going to go away—no matter how much misinformation they publish.