Stock-picking institutional investors now buy more index ETFs than individual investors.
When firms that exist to deliver above-benchmark returns for their clients are loading up on index funds, you can be pretty sure they’re active tools.
That said, the investing world is certainly buying index products more often. The trend is fashionable but, as with many investing trends, pitfalls await.
Eighty-five per cent of assets under management in top index funds is focused on American companies—it is a de-facto US investment strategy, in most cases.
Given the US has outperformed non-US for the last four years, going “passive” generally looks a whole lot like chasing heat.
Since the inception of the MSCI indexes in 1970, US stocks have never outperformed foreign for five consecutive calendar years. There is no set rotation schedule, so by itself this doesn’t mean a lot.
But there will be a rotation eventually, and when it happens, history shows foreign can lead for a long time and by a lot, just as US stocks have recently.
During the 2002 – 2007 bull market, for example, US stocks gained 119 per cent, while non-US developed country stocks did far better, up 222 per cent.
This highlights a key point: when foreign outperforms, what will the so-called passive investor” do? Remain passive or take action? History and human psychology suggest the latter.
In my view, both active and passive professionals must counsel clients through big up and down markets, protecting them from harmful mental miscues, such as shunning global diversification because one region has outperformed in recent years.
This is a big challenge, requiring both resources and commitment. But it’s also an unmet opportunity.
Tremendous client service - not walking someone’s dog when they ask, but counseling them through hard times - isn’t the norm in our industry, and those who embrace it can set themselves apart.
This is one active choice all investment professionals, regardless of investment philosophy, should make.
Damian Ornani is chief executive of Fisher Investments