Benjamin Felix December 4, 2014 Market Research The Growing Momentum of Index Investing Index investing, passive investing, and market-based investing are synonymous terms for an investing approach that has seen a steady increase in popularity over the last decade. The idea that any investment manager is able to produce superior returns that beat the market has been consistently eroded by their evident inability to do so. There is very little evidence that any individual or firm that engages in active management is able to predictably produce the market beating returns that would justify their high fees. Contrarily, the evidence in favour of index investing has continued to build, and it has not gone unnoticed. Through 2014, the media has had a field day exploiting the data that is making both institutional and retail investors question their approach to financial markets. Back in May, The Economist had a headline reading “Cheap is cheerful” followed by a discussion of the industry’s imminent shift toward low-cost index funds. In August, a Wall Street Journal headline read “The Decline and Fall of Fund Managers” followed by the statement that the debate between passive and active management is over. The New York Times shunned active management in July with the headline “Heads or Tails? Either way, You Might Beat a Stock Picker,” explaining that over the last five years, actively managed stock mutual funds have performed even worse than would have been predicted if the fund managers were flipping coins instead of picking stocks. Another July headline from the New York Times read “Who Routinely Trounces the Stock Market? Try 2 Out of 2,862 Funds”. TIME Magazine’s September 18th headline read “The Triumph of Index Funds” after the California Public Employees’ Retirement System began shifting assets from active management and hedge funds into passively managed index funds. This media trend of bashing active management was present in Canada too, as National Post’s headline “Andrew Coyne: Canada Pension Plan’s active management strategy is a crock” clearly indicates. It didn’t help the case for active managers when Warren Buffet stated in his annual letter to Berkshire Hathaway shareholders that his heirs are to invest their inheritance in low-cost index funds. Investors are voting with their dollars. In the retail market, the Vanguard Group (which manages mostly index funds) has taken the lead as the largest mutual fund firm in the world, with over $3 trillion in assets. As at September 2014, Vanguard had seen $57 billion of inflows to passively managed products for the year while investors pulled $59 billion from their actively managed stock funds. Vanguard’s experience is not unique. A recent survey from Cerulli Associates established that the market share of retail index funds has increased from 13% to 24% in the last ten years. Retail index funds have gathered more money than actively managed funds in the U.S. in four of the last six years. Canada is lagging behind this trend with index funds capturing a modest 6% of market share according to BMO Asset Management. It can be speculated that this is attributed to Canada’s distribution network consisting largely of commission-based sales people who are not motivated to recommend index funds, whereas the US is largely shifting away from commissions to the fee-based model. On the institutional front, Cerulli Associates found that the vast majority (88%) of the U.S. institutional investment managers they surveyed expect the market share of institutional index funds to exceed 20% in the coming three to five years, and almost four out of ten institutional managers believe this market share will even exceed 30%. The bottom line: An overwhelming amount of data shows that investors are better off cutting their costs and investing in the index rather than paying high fees for unreliable promises of outperformance. Following this evidence, as the media and investors are starting to do, will lead to an increasingly positive investment experience. This blog post was written in collaboration by Benjamin Felix, PWL Investment Advisor and Raymond Kérzerho, PWL Director of Research. Share: Facebook Twitter LinkedIn Email IIROC AdvisorReport