Where Active Management Is Headed

If index funds are core, where does that leave active management

John Rekenthaler 08 November, 2016 | 14:42
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An article "The Dying Business of Picking Stocks" published around mid of October, the Wall Street Journal all but buried active stock management. According to the Journal, the great mutual fund battle is over. The index funds have won, leaving actively managed funds reeling for the foreseeable future. That is correct. The reasons are many. Logic supports low-cost indexing (higher-cost indexing is another matter). The numbers support it. So, increasingly, do legal pressures--401(k) plan sponsors in particular are becoming conformist. No wonder, then, that index funds now account for more than 100% of the industry's net sales.

Active management has three credible responses, each of which is already occurring, to various degrees. As more active managers face reality, these three trends will accelerate to the point where they become dominant. Few of today's actively managed funds will survive in their current forms.

Discount Goods

One tactic is to become a discounter. Vanguard's actively run stock funds are much cheaper than most in the industry, but they still cost several times as much as their index funds. 24-basis-point gap in expense ratios might not seem like much. Historically, it wouldn't have been perceived as being important. But again, times have changed. These days, index funds compete among each other for the tiniest of advantages. A few basis points can make the difference between a best-seller and an also-ran.

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John Rekenthaler  is vice president of research for Morningstar.

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