Active asset managers are carving out distinctive strategies to try and fend off the marketwide migration to passively run investment vehicles.
The investing landscape has undergone a dramatic shift in the last decade. Investors have shied away from high-cost, specialized investment strategies offered by active asset management companies, instead favoring passively run investment products that track broad market indexes such as the S&P 500.
In April, investors pulled $11.4 billion out from active strategies and put $18.2 billion into U.S. equity passive funds, according to Morningstar. Investors removed a total of $207.5 billion from U.S. equity active funds during the full year of 2017, while $220.4 billion was added to U.S. equity passive funds.
Yet active managers are hopeful about their future prospects. Volatility's return to the market, rising rates and investors' interest in environment, social and governance investing have become bright spots for active investment managers, who market their abilities to craft unique investment strategies as a valuable asset.
"This business is about performing for your clients and adding value beyond the benchmark," Reik Read, a managing director with Baird Equity Asset Management, said in an interview. "There are certainly opportunities for active managers to add value."
The migration toward passive strategies has been developing for decades, due in part to active managers' historically high fees, said Read, an active investment manager. In a push to stay competitive with their passively run counterparts, many active management companies have slashed their fees.
In 2017, the average expense ratio for actively managed equity mutual funds fell to 78 basis points, down from 108 basis points in 1996, according to data from the Investment Company Institute.
That has helped narrow the competitive pricing gap between the two types of funds, but index funds are still far less expensive. Index equity mutual fund expense ratios averaged 9 basis points in 2017, which was down from the 1996 average of 27 basis points.
"We've gone to the lowest common denominator at the expense of the investor," Ariel Investments LLC President Mellody Hobson said June 12 at the Morningstar Investment Conference in Chicago.
Still, active managers hope to slow the amount of outflows from active strategies by promoting their distinctive investment strategies. An exchange-traded fund tracking the S&P 500 has to include partial ownership of each of the index's 500 companies. But active managers are able to design a portfolio of stocks around their clients' specifications.
Baird Equity Asset Management’s MidCap Fund, for example, tracks a select group of “high-quality common stocks selected for growth potential,” according to the company. The fund, which was composed of 58 separate securities at the end of March, has at least 80% of its net assets in midsize companies, and saw a total return of 26.9% in 2017, outperforming the Russell Midcap Growth Index’s total return of 25.3%. The fund charges an expense ratio of 1.09%.
The rise of ESG investing has put a spotlight on active portfolio construction. More investors are seeking strategies that allow them to put their money into companies, industries and markets that fit their specific personal interests. More than 80% of asset owners are considering or have already started to integrate ESG factors into their investment processes, according to a June report from the Morgan Stanley Institute for Sustainable Investing and Morgan Stanley Investment Management Inc.
"If you're buying a house, do you just look for whatever house is available within the price range you can afford?" Frost Investment Advisors LLC President and Chief Investment Officer Tom Stringfellow said in an interview. "I would think that most people will do their homework and buy something they're looking for."