Passive Investments

The Wall Street Journal reported a slowdown in asset flows to passive investment managers in the first half of 2018:

“That was the lowest amount of new monthly money for these funds since early 2014. For the first six months of 2018 passive inflows were down 44%, compared with the same period a year earlier.”

There are a few ways to look at this, one being the fairly steady rise of the market over the past decade. During periods of fairly stable market returns, passive investment strategies tend to outperform active management, minus their costs. Hence, investor dollars move toward those strategies.

Active fund managers tend to gravitate toward this strategy, probably because it gives them hope for the future. Maybe one day the market will drop and money will flow back to them again. Maybe they’re right:

“The drop-off in investor cash during 2018 is the result of political uncertainty and concerns that the bull market could eventually stop, said Emily Farrell, a Vanguard spokeswoman.”

I mean, the good folks at Vanguard are probably half right. People are concerned about the market and there is political uncertainty. I guess I take issue with the phrase “the bull market could potentially stop.” In fairness, said representative is just being diplomatic, but I’m willing to go out on a limb and say that the bull market will definitely stop at some point.

Having worked in financial services for more than 10 years I can say with certainty that we have had market pullbacks as bad or worse than we have seen this year, as well as dramatic political uncertainty. Regency biases make us feel like it’s never been this bad, but trust me, it has. All of that didn’t stop index funds’ meteoric rise over the past decade.

The other way to look at this is a more optimistic perspective. After years of marketing to consumers that investor behavior is more important than stock picking and that ultimately, the market in general is a (relatively) safe place for their money, people are willing to broadly and inexpensively invest their money for the long term. I tend to agree with this message. Our firm is a little biased because we have an expert investment team. Without access to a group like ours, buying and holding an index makes a lot of sense. Active risk management doesn’t make sense for every client, or even every account, and when we aren’t recommending our trade group’s specialized risk management, we recommend passive buy and hold strategies. We don’t recommend actively managed mutual funds.

The rational conclusion is that the initial, low-hanging fruit of investor dollars has already transitioned to index investments and the flows from here will be slow and steady. Certainly, everything moves in cycles and one day investor dollars will start flowing back to active funds (maybe smart beta!) but it’s not today. The passive investment story is far from over.

Indexes

Speaking of indexes, The Financial Times reported on investor concerns over Unilever’s potential move to the Netherlands.

Why do investors care, you ask? Surely, the company would only move the headquarters if it benefited the company, right? And something that benefits the company should benefit shareholders, shouldn’t it?

Good questions! A move to another country would likely cause the company to be ejected from the FTSE 100 index it is currently part of. In fact, Unilever is the 9^th largest company in the index, leading to substantial investment from index-based funds.

“Passively managed funds that use the FTSE 100 as their benchmark will be forced to sell their shares if the company is ejected from FTSE Russell UK indices, while actively managed funds could also be affected if they face restrictions on having large holdings in companies that are not in the index.”

This has investors worried! Active and passive funds divesting shares could drive down the price of the stock and hurt individual investors. Most people feel as though corporations and their boards have an obligation to maximize shareholder value. For example, Unilever makes Lipton Tea. We can easily conclude that Unilever should not start putting dirt in every other Lipton tea bag because eventually people would start buying a different tea. Maybe they would attract a new market segment (people that want to drink warm mud) but it would be insignificant compared to the people that only want tea. This would be bad for shareholders, so the company shouldn’t do it.

That is an exaggerated example but it’s very clear, isn’t it? What about decisions that are good for the company but potentially bad for the stock? Definitely, less clear. In this case, the board seems particularly uninterested:

“Three large shareholders said that the company had not given satisfactory responses to concerns during meetings. A top-10 shareholder, who has spoken with the board twice about the plans, said Unilever had been ‘almost belligerently unreceptive’ to the concerns of British investors.”

So, I guess it’s clear to people close to the matter.

Also, other stuff:

AT&T Time Warner Will Get Another Look

The Most Important Number in Finance Is Going Away. Wall St. Isn’t Prepared

Netflix Was the Great Disruptor. Will It Now Be Disrupted?

Trump’s Tax Cut Hasn’t Done Anything for Workers

Your Haircut Is (Probably) Too Cheap

Hell for Elon Musk Is a Midsize Sedan

Elon Musk Pledges to Pay for Clean Water to Home in Flint, Michigan

Twitter’s Crackdown on Fake Accounts Will Make You Look Less Popular

Gainplan LLC is a Registered Investment Adviser. This blog is solely for informational purposes and not a solicitation to invest. Advisory services are only offered to clients or prospective clients where Gainplan LLC and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Gainplan LLC unless a client service agreement is in place. Please contact a financial advisory professional before making any investment.

Gainplan LLC provides links for your convenience to websites produced by other providers or industry related material. Accessing websites through links directs you away from our website. Gainplan LLC is not responsible for errors or omissions in the material on third party websites, and does not necessarily approve of or endorse the information provided. Users who gain access to third party websites may be subject to the copyright and other restrictions on use imposed by those providers and assume responsibility and risk from use of those websites.