Passive Is The New Active

How active asset managers are jumping on the passive bandwagon.

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The exponential growth of the passive sector in the investment industry over the past few years has been spectacular. ETFs are taking up a big slice of the market while the active side has barely grown. This sharp contrast has had active managers scrambling to react, from trying to acquire an existing ETF venture to starting their own ETF division. Some acquisitions work, but some have been hindered by cultural or operational integration, and some have seen their share prices punished for their ill-fated acquisitions.

Of course, many active managers still preach the benefits of their traditional strategies, and some of them have launched a new form of active-nontransparent ETF to refresh their offerings to clients. Yet we are also witnessing more active managers crossing over to the passive space with innovative products that are definitely worth a look. 

Some active managers have partnered with index providers to codify their active investment philosophy into rules-based indices. These indices are used as a conduit to access the passive sector in a more nuanced manner. They can be used to launch an ETF, a passive fund, or even packaged into structured products or fixed index annuities.

Fidelity, for instance, launched the Fidelity AIM Dividend Index - a multi-asset index combining equities and fixed income that is sold in the insurance annuity space by Lincoln National. Fidelity has also launched dozens of indices that are sold in index funds, such as the Fidelity U.S. Large Cap Index (2018) which is used in the $2 billion fund. Goldman Sachs Asset Management, which used to run mostly active funds, launched the Goldman Sachs ActiveBeta U.S. Large Cap Equity Index (2015) using a quantitative, passive factor screening approach. The index is used as the underlying a $10 billion ETF.

Fixed index annuities are another product where active managers are creating passive indices and becoming increasingly involved, partly in response to the fact that big buyers like insurance companies now often use fixed index annuities instead of variable annuities. Even BlackRock, which typically uses indices from well-known benchmark providers in their ETFs, has created a number of passive indices for the first time in order to access the market.

Meanwhile, AQR, the well-known asset manager/hedge fund, has developed an index for annuities that is sold by AIG. The AQR DynamiQ Allocation Index, uses equity factors and fixed income underlyings with price momentum and dynamic risk control features. Alliance Bernstein, Franklin, Putnam and PIMCO have all developed passive indices for this market, many featuring the use of mean variance optimization and volatility control mechanisms.

The above examples highlight the complementary and relatively cost-effective ways that allow forward-thinking active managers to expand into the passive space. We may well see more active managers follow suit, giving investors more choices but at the same time making it harder to differentiate one index from another. In turn, this makes index ratings even more important than before to boost investors’ understanding and selection.

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