Figure 1

Will index funds continue to beat active funds?

Introduction

Today, only a few active funds can compete with index ones. As for most individual investors, investing ETFs (Exchange traded funds) or other index funds can be the best option. Moody’s Investors Service anticipated passive investment will outweigh active ones in the United States until 2021 (Kim and Cho, 2019). Therefore, most active fund managers will no longer be able to charge the fund fee. As a matter of fact, according to figure 1, the fund fee, even asset weighted average one, has been decreasing steadily as active fund fee has done so (Platt, 2019).

Unethical Issues

However, these investment trends might involve several problems such as gender and unethical issues. One of the major dilemmas is to invest the funds indirectly if the companies indexed by the funds act unethically. In fact, no less than half of United States listed companies income was created from alcohol cannabis or tobacco (Nauman, 2019). This means the investors are in favor of such corporation revenue taking activities at least circumlocutory. In addition, investing the fund can be equal to advocating gender bias. To illustrate this, the number of female hedge fund employees was less than a fifth of the total employees (Fortado, 2019).

‘Correct’ Index Funds

To avoid the issue, the Investors can choose ethically or politically correct index funds such as ETFs having a gender lens and higher environmental, social and governance (ESG) criteria (Bolshaw, 2019). However, the most critical matter for the investors is to earn enough money, which has to be at least bigger than the deposit rate or the government bond one. There is a tendency for women led funds to gain higher revenue than male one (Fortado, 2019). This might mean even if the investors select ethically appropriate ETFs, it may earn the expected income. Therefore, this passive funds preference probably does not change.

Conclusion

As a result of this trend, there may be new arbitrage opportunities. Michael Burry argued that the tendency in passive investment through ETFs and index funds, as well as the trend to quite large size among asset managers has strayed smaller cap stocks without exception (Kim and Cho, 2019). According to his statement, if this direction continues, non listed small cap stocks will be undervalued more than ever. Consequently, these companies may not collect the money to expand the current business or build a new one from the capital market. However, in this situation, the small cap funds can overcome the passive ones as for the revenue. This may mean active funds oriented for smaller cap might beaten ETFs. As a consequence, the index funds will dominate or have already done, though, the dominance will no longer last.

Reference