Active managers engage in ‘hopeful fantasising’ over decline, research warns

A new study highlights cognitive dissonance in the active management community

Theo Andrew


The active fund management community has been accused of engaging in “hopeful fantasising” and “cognitive dissonance” over their decline versus passive investing, according to a new academic study.

Recently published research titled, Active fund managers and the rise of Passive investing: Epistemic opportunism in financial markets, found active managers would rather engage in “discursive boundary work” in a bid to justify their high fees and underperforming funds rather than adapt to a shifting financial regime.

The study, authored by Crawford Spence from King’s College London, Yuval Millo from Warwick Business School and James Valentine from Marquette University in Wisconsin, interviewed 69 active managers in a bid to understand how active managers were reacting to the meteoric rise of passive investing globally.

The research found active managers were engaging in four defensive strategies instead of proactively finding solutions to their falling market share, comprising of; asserting a strong identity, delegitimising others, framing a practice as inaccessible and hopeless fantasising.

Of those interviewed, just five said their firm were undertaking measures to adopt new investment techniques or training with many actively conceding the superiority of index funds.

However, the research argues while passive investors do all they can to ensure investors invest passively, the active industry is “inactive about its own decline relative to index investing”.

“Rather than proactively outlining adaptation strategies, we found that interviewees engage in discursive boundary work that aims at justifying their doing the same things that they have always done,” the research authors wrote.

It noted “institutional factors” which support the status quo. For example, despite the loss in market share to passive funds, active managers are still “marginally increasing” assets under management year on year.

The study did highlight the practical issues faced by active managers because of the rise of passive investing including the price distortions created by momentum trading by passive funds and “robotised ETFs”.

Passive funds – including ETFs – own on average 21.2% of every company in the S&P 500, according to data from Bloomberg Intelligence, with the ‘Big Three’ of BlackRock, Vanguard and State Street Global Advisors dominating ownership.

Moving forward, the research suggests the battleground between active and passive investing will not be decided by who yields better returns – with many active investors acknowledging passive generates better results – but about which is the right set of beliefs about the market.

An active edge in ESG?

One area active managers justified the continued allocation of capital to active funds was ESG, arguing that passive funds were unable to incorporate meaningful sustainability factors into their investment strategies.

The ability to engage the corporate board through voting and shareholder resolutions was described by one active fund manager as their “secret sauce” while the ability to divest was also seen as a strong tool in the active funds’ toolbox.

However, the research questioned whether divesting was effective in bringing around change, noting that passive funds’ inability to divest meant they were “forced in effect to engage” with companies and therefore “more likely to bring about change in corporate behaviour”.

This was also the view of former global head of sustainability for HSBC Asset Management Stuart Kirk who said ETF investors have a more “legitimate role to play” when it comes to ESG investing because they have more “skin in the game” than active managers.

“They have a bigger and more legitimate role to play because they have a seat at the table. The average number of holdings in an ESG ETF is about 1,300 stocks while the average number of holdings in an active fund is 20 to 50. They have excluded so many stocks,” Kirk said.

The authors concluded: “If investors want to be ethical, we were told that they would have to enlist the help of the active community.

“Such criticisms notwithstanding, ESG appears to have emerged as a key justification for the continued allocation of capital to the active fund management industry.”

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