Is this the beginning of the end for active fund managers?

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'When you're underperforming the index, you go home at night and cry in your beer. It's not fun, but who said this business should be fun? We're too well paid to hang our heads and say boo-hoo' – Bill Gross

Active fund managers were once treated like royalty. Red carpets, crowns and flowing robes; I’m kidding about the robes and crowns but I guess the red carpets may not have been out of place a few years ago. Fund managers were the enablers of wealth creation, at a pace much quicker than what equity and bond indices gave you. And in turn, they made a lot of money too.

But things began to change. The time of equity rockstars like Peter Lynch and the OG of bonds, Bill Gross, was over. The markets started winning and the Darwinian theory of survival of the fittest took hold. Investors started flocking towards low cost index funds and active fund managers got nervous. Fund managers changed their styles of investing—what’s known as style drift—in order to do better, but success was limited. Soon, there was a tsunami of support for indexed funds.

Now, not only are global fund managers reducing fees on their active strategies but they’re also realising an urgent need to launch their own passive funds. It’s turned into what has been known as 'feemageddon', with Fidelity launching a no-fee index fund in 2018, which raised $1 billion in the first month. Now that should tell you something. But active managers haven’t completely given up; global players such as PIMCO, BlackRock and RWC have enlisted high-profile advisors on economic matters and policy in order to aid active management in a better way.

In India, however, things aren’t that bad. Over the past year or two, questions have been asked of fund managers and if you look at the returns, you may be hard pressed to think of reasons why you should be investing in active funds. Fund managers put this down to being an outlier, list a couple of reasons and showcase their long-term track record as proof that active fund management still has its place here. Mutual fund distributors and advisors hang on to a fund manager’s every word during their talks and meetings. Of course, the advisory community makes their own judgement; but the overarching belief is that fund managers know it all—whether it’s politics, economics, asset allocation or stock picking. In order to gain as much informational advantage as possible, the larger fund houses even have their own slew of economists that they consult with, just like they do globally. If you ask the fund managers though, they’d say that their stock picking is all bottom up. Why do they consider ‘top down’ to be a dirty term?

For the ones who’ve been in the markets since the beginning (a couple of decades) and are at the pinnacle, they’re still rockstars because they have the track record to back it up. For the others, the going could get tougher. Certain asset management companies have launched passive funds while communicating the difficulty that large cap funds have in outperforming the index and even in midcaps. With the recent change in Sebi regulations restricting mid cap fund managers primarily to a pool of 150 stocks, they’ll have their work cut out for them. As a fund manager once said, being a midcap fund manager could be a career risk in this environment.

What it could mean is that the number of funds that are index huggers could fade away in order to make room for more concentrated and active bets—and this could lead to highly divergent returns. But there are no reliable ways to identify good performing fund managers ahead of time and it’s not because of lack of trying. You would think that with the amount of data out there, making a choice is easier. But, no, it’s actually getting harder to choose. A couple of things though are clear—one is that a large fund size does not allow them the same flexibility to outperform and that the mandatory benchmarking against the total return index means that illusory outperformance you were used to seeing earlier has been pegged lower.

It has also led to quite a fair number of mutual fund managers leaving to set up their own outfits in the PMS (Portfolio Management Services) or AIF (Alternative Investment Fund) formats. And if you look closer, you’ll also realise that the vast majority of them concentrate on the multi-cap or small cap segments, where they see a more significant opportunity to create that elusive alpha and earn their bread too. Maybe a decade from now (or sooner), if the alpha disappears across segments, we could see fund managers migrate to being financial advisors as well.

The writer is co-founder of Investography, a financial wellness company based in Bengaluru. He can be reached at nithin@investography.in

The thoughts and opinions shared here are of the author.