The US Department of Labor’s Fiduciary Rule – set to come into effect from April 2017 – is expected to further promote the shift towards passive investing strategies.
The legislation means finance professionals who manage retirement plans will be considered as fiduciaries who must place the interests of clients above their own. Among other things, this means investment advisers should no longer have an incentive to promote products that have high commissions.
Passive investment strategies generally carry much lower fees than mutual funds and other actively-managed alternatives. Coupled with the fact that most active fund managers fail to outperform the market consistently (after taking into account the fees they charge) this has meant demand for passive products is growing rapidly.
The impending legislation has also prompted providers of passive strategies to further reduce fees. BlackRock, the world’s biggest asset manager, said in October 2016 that it would lower the management fees of several of its ETFs.
The rise of passive investing
Professional services firm PwC expects the value of passively-managed funds to reach $23.2bn globally by 2020, a more than threefold increase in just eight years.
The most accessible passive products are ETFs, which track underlying indices and which are generally accessible for both institutional and retail investors.
While indices are traditionally weighted by the size of each constituent (in other words, bigger stocks make up larger proportions of the index), alternatively-weighted indices are gaining in popularity.
Smart beta and risk premia indices, as they are commonly known, aim to generate superior risk-adjusted returns by making tilts towards certain risk factors such as value or low volatility. Smart beta and risk premia strategies are in many ways a compromise between active and passive investing.