EFAMA’s European equity plan a ‘veiled attempt to boost fee income’

‘Asset allocation is a decision for investors’

Alex Matturri

Alex Matturri

The European Funds and Asset Management Association (EFAMA) and the French Association of Financial Management (AFG) are criticising index product issuers for not encouraging a home country bias.

They are arguing for increased allocation to European equities. While wrapped in nationalism, this is part of the continued campaign by the active management community to try and mitigate the continued shift of assets from active to indexed strategies.

Typically, the arguments are centered around the theme that 'the time is right for active to outperform'. Often this is combined with a view that the market conditions are now more suitable for the skill of an active manager.

Unfortunately, as the studies have shown, regardless of market environment - bull versus bear markets, highly correlated versus uncorrelated markets, inefficient versus efficient asset classes - the results are the same.

Over time, active managers, on the whole, will underperform. While there are some managers that can outperform, the ability to select them prior to their period of outperformance is quite hard. This has been the message of the index industry for some time.

There have been many arguments presented as to why index-based products are bad for investors.

These include, but are not limited to, the impact to price formation, indexing is a momentum strategy, concentration of voting control among a few index managers leads to a lack of competition among companies within an index and my personal favourite, that indexing is just 'un-American' - with apologies to the European index community.

But now, EFAMA and AFG have taken the argument against indexing to a new level. The argument is that offering global and US focused index products to European investors is harming local capital markets and economies.

To correct this problem, index managers should 'encourage' a home country bias and thus minimise the flow of capital out of Europe and to the US.

This argument is a non sequitur. First, asset allocation choices are not the responsibility of index product providers. All the major index managers offer a broad array of products with differing types of country and regional exposures.

No one is forcing an investor to invest in a global or US focused index product. If a global index product has a higher allocation to the US and thus a lower allocation to Europe, that is a function of the relative market cap of the US within global markets.

This is not a product design feature: This is a function of the market caps of equities as determined by market forces. If someone chooses to maintain a home country bias, they can easily invest in just a regional index or combine a global index with a separate allocation to a European index.

If European asset managers feel investors should increase their European allocation, this is not an argument to be directed to index product issuers. Asset allocation and country selection is an active decision to be made by investors and their advisors, not index managers.

The real issue here is that as active managers in Europe continue to underperform, investors are turning to indexed alternatives.

Trying to mandate increasing the allocation to Europe as a way to support local capital markets is a veiled attempt to bolster assets under management and thus fee income.

This is not about the best interest of European investors or maintaining the robustness of capital markets.

This response is a very European approach which, rather than allow market forces to dictate outcomes, calls for turning to policy makers to minimize 'unintended outcomes' of the rise of indexing which benefits US over European corporates.

Persistent underperformance of European markets, which is driving flows to the US and thus increase US capitalisation and weightings relative to Europe, is tied to lower economic growth in Europe, strength of the US dollar and other fundamental factors.

None of this can be attributed to index managers or index providers. Investors have a choice and if they select global or even US exposure products, that is based on a view of expected returns or just a desire to have a well-diversified portfolio.

Using a well-designed global index offered in a low-cost ETF or index fund reduces risk further as that is about as close as one can get to Markowitz’s 'market portfolio'.

The messenger here is the flow of capital as witnessed through the lens of indexed products. The real problem is the economic disparity between the US and Europe and European active managers watching assets - and revenues - flow out.

While solving global economic issues is beyond my scope, a better approach is improving the economic competitiveness of Europe which could lead to improved market performance.

An idea more in the control of European asset managers is to provide products that perform as expected - i.e. do not underperform - at reasonable fees while also focusing on European exposure or, better yet, get on the index bandwagon and provide products investors want.

What is not a good solution for European investors is to 'encourage' increasing a home country bias and attacking indexed-based solutions.

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