The rise of passive funds, ESG investing, and the outlook for 10–year treasuries were among the subjects tackled by our distinguished panel at the Lipper Alpha Forum in New York.Is the asset management industry experiencing a period of evolution or revolution?
This question formed the basis of our discussion at the Lipper Alpha Forum, as panelists from PIMCO, Nuveen and Oppenheimer considered innovation and transformation in the sector, including the attack on active management from passive funds.
Other topics in the wide-ranging conversation covered wealth transfer and changing investor demographics, as well as the outlook for U.S. government debt.
The discussion was enhanced by contributions from the Lipper Alpha Forum audience through interactive polling. On the panel were:
- Vijay Advani, CEO, Nuveen
- Sharon French, Head of Beta Solutions, Oppenheimer Funds
- Jerome M. Schneider, Managing Director and Head of Short Term Portfolio Management, PIMCO
The moderator was Jeff Goldfarb, U.S. Editor, Breakingviews.
With passive funds now accounting for 36% of the U.S. market, compared with 18% in 2007, Goldfarb asked the panel and audience where they thought this figure might rise to.
Q. When will passive management account for 50% of total US fund assets?
The majority of the audience said “Never”, although our panelists predicted the figure may well hit 50% in the distant future.
Sharon French insisted the answer is not never, as she predicts passive funds hitting the 50% mark in 10 years. She said: “Under-rated funds (one and two star funds) are being eliminated, while smart beta is rising.”
Vijay Advani agreed that reaching the 50% mark is possible, but not for another decade. “The death of active is highly exaggerated. Active supplemented by passive strategies is the new normal,” he said.
Jerome Schneider noted that trajectories are entirely different for fixed Income, where “active is superior in many ways,” especially in a rising rates environment.
He said: “In my world, which is the front-end, short-term, low-duration world, data is clear that benchmarking is actually dangerous.”
As an offshoot of the active vs passive debate, Goldfarb asked the panelists about fee compression, quoting a Morgan Stanley study that found fees may be a bigger factor than performance in terms of determining flows.
Q. Where will 10-year treasuries be at the end of 2018?
The majority of the poll responses thought they’d be pretty much unchanged.
Jerome Schneider had a different take. He said the reason to load up on fixed income now is diversification, particularly in shorter-term portfolios.
He said: “We see a lot of interest there because people are trying to de-risk against volatility.” They are re-allocating versus what they had set up two, three, four years ago.
And because rates are finally heading up, he is seeing a lot of flow from people taking a longer-term view, like pension funds, as well as for income.
He noted that the U.S. has had some good quarters, and Europe is also seeing improvement now as yields are moving higher.
Q. Is ESG investing a competitive advantage? If not now, when?
Sharon French has spent a good deal of time studying ESG funds.
She said: “We’re not there yet, but I believe it will be a way we just normally invest in the future.” She added that ESG is bigger outside the U.S., but demographics and other trends point to much bigger growth.
She noted these three trends:
- Corporate standards have risen significantly, with many companies (she cited our company among others) already keen on governance, diversity and inclusivity.
- A massive demographic shift as there are 90 million millennials, many of whom are more interested in investing in their values than previous generations. They will also have money to invest as baby boomers are transferring US$30 trillion to their millennial children.
- The influence of women as investors. A recent Morgan Stanley survey found that in the next decade, women are going to control two-thirds of the wealth, and women by a 2:1 ratio vs men want to invest in accordance with their values.
Sharon French added: “Why wouldn’t you invest according to ESG principles? It not only helps you keep pace with the market, but actually delivers alpha.”
Vijay Advani said Nuveen’s TIAA group has been using ESG in the investment process for many years, and truly believe it’s an important factor.
“Five to 10 years from now I don’t think we’ll be talking about ESG the way we are today. It will just be part of the DNA.
Look at governance — any analyst will look at that as a factor. Without good governance, you’re not going to find value in a stock.”
Q. What annual return can an investor expect from a balanced portfolio over the next five years?
Both the polling results and panelists noted muted expectations about returns, due in part to lingering effects of the 2008 downturn, and a current sense of uncertainty and market volatility.
Jerome Schneider noted that “we’re mostly institutional investors, but we hear from retail and quasi-institutional investors and they’re more concerned with volatility than returns.
“People will shoot for 7% and more, but say I’m fine with 3% if it means I won’t lose sleep at night.”
Sharon French sees much the same psychology at play.
“The crisis of 2008 still weighs heavily and there’s a permanence of the psychology, especially with retail clients and millennials. Many of them have no aspirations of 12% returns.”
Vijay Advani said returns could reach of 5-6% with products like liquid alts.