The Continual Shift to Passive Investing
In a growing trend, public investors are embracing passive investing for a number of reasons. In the past decade, active equity risk has not been rewarded for many public investors; focus has been placed on investment process and risk management. The cost of passive investing is inherently inexpensive compared to active management. There is little career risk for investment officers in passive investing; the blame can go to beta, rather than picking a bad performing active manager. Some public investors feel that passive mandates give them greater oversight on manager underperformance and the ability to quickly identify downside risk. In addition, with passive investing there is usually a defined systematic process. Investment transparency provides asset allocators with greater insight to risk exposures.
Funds like the Abu Dhabi Investment Authority have a major passive investing allocation. It is difficult to find active managers who can generate sustainable alpha. In addition, there can be periods where good managers can under perform. Active management for investing consumes more financial and time resources. Additional due diligence costs and constant monitoring are additional tasks that are undertaken. Many CIOs believe that the majority of investment returns come from asset allocation rather than external manager selection.
Newer forms of passive investing are emerging to bridge the gap to active management. The traditional market cap-weighted indices are not the only solution. Alternative indices and customized betas solutions are being implemented. Alternative beta products are popping up everywhere, some based on factors such as dividends, volatility, or fundamental factors.