While very few advisors are recommending entirely passive investment menus to clients, there’s no doubt that indexing is on the rise and gaining momentum. Witness Vanguard’s record this year: $163.4 billion in flows, which in 10 months surpassed the record $141 billion in 2012.
So what’s the solution? According to a Towers Watson white paper, reduce the amount allocated to active managers, many of whom get paid by buying and selling assets to each other without adding value, from the current 80% to 25% of assets.
Using a “virtual warehouse” analogy, Towers says that there is a fixed amount of assets owned by investors, which produces a certain amount of cash or dividends. There are three basic types of managers receiving the following hypothetical fees:
- indexers at 15%, receiving $1
- active managers at 80%, receiving $40
- hedge Funds at 5%, receiving $15
Towers suggests that the percentages should be — and actually will be — shifted to indexing, which it says will better serve investors. It hypothesizes that if 70% of assets were indexed, 25% were actively managed and 5% were in hedge funds, investors would save 41% of the fees they currently pay — and even more if indexers cut fees as assets grow.
Taking into account more DC regulators around the world looking to cap fees (like in the UK, for example), the growth of aggregated assets in DC plans, larger and more skilled investor groups and moral outrage in the wake of the Great Recession, Towers believes its scenario is likely to play out, though they do concede it will take time.
What’s your take on Towers’ proposition? Share your thoughts on the comment box below.
