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We Are All Active Investors Now

Strategic asset-allocation decisions determine most of an investment portfolio’s subsequent return. Investors need to focus more on the composition of their portfolios and worry less about whether they are actively or passively managed.

ZURICH – Investors have long debated whether their portfolios should be actively managed or passively track a market index. But that discussion is becoming a sideshow. Encouragingly, attention is shifting to what matters most: the active decisions about strategic asset allocation that largely determine subsequent investment returns. To paraphrase Milton Friedman in the 1960s, we are all active now.

True, passive global exchange-traded funds (ETFs) have experienced explosive growth – from just over $200 billion in assets in 2003 to more than $4.6 trillion last year – which has enabled them to gain market share from more expensive actively managed funds. And investors should always take the lower-cost option if paying higher fees for an active fund brings little additional value (especially during bull markets, when simply being in the game can yield outsize returns). Yet the rapid rise of low-cost ETFs has had two other important effects on investment management.

First, active management fees have come under pressure, particularly for weaker-performing funds. For example, the proportion of hedge-fund managers charging “two and twenty” fees –a 2% management fee plus 20% of any profits earned – has fallen below one-third. Given mediocre hedge-fund performance over the past decade and the emergence of liquid alternatives, it’s surprising that fees haven’t fallen further. Moreover, average fees for active funds across all investment strategies fell from about 1% in 2000 to 0.72% in 2017, a downward trend that shows no signs of abating.

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