csen
Why I’m Fading the Demographic Bull Market in Passive Investing

The next 5, 10, 15, maybe 20+ years of investment management flows are going to favor quantitative/algorithmic low cost passive investing over active investing. This may be the consensus view at this point, but let me explain why, and what that means.

-Institutional money, especially pension funds/endowments, is run by people in their 50’s, 60’s, and 70’s who have long-standing relationships with the managers they’re invested with. These guys survived a whirlwind over the past 15 years, and are looking ahead to retirement.

-The big fund managers are being fed by the group above. They came up in the ’80s and ’90s, and ascended to the throne over the past 15-20 years. Bill Gross might be an extreme example, but he’s not alone. They have no succession plan, and have mostly closed ranks since 2008.

-Unproven managers haven’t been given a real shot in 5-10 years. And there’s no pipeline with bank prop desks a thing of the past.

-As the first two groups above retire — allocators and fund managers — skeptical, cynical Gen-X will ascend to the throne. They’re going to look at the after-fee returns generated by high cost active managers since 1999-2000 and it won’t be pretty. Meanwhile, low cost algorithmic platforms like Wealthfront are ramping up. You’re going to see hundreds of billions of dollars move from active to passive.

-The two rising generations of investors, Millennials and Gen-X, are skeptical of active investing for different reasons. Gen-X saw the dot com lunacy and then the corruption of the system over the past 10-15 years. Millennials are just scared, and not enthusiastic about investing the way prior generations were. Both of these generations will be natural clients for algorithmic products.

-The irony is, Gen-X CEO’s appear to be pretty good stewards of capital. Favoring pragmatism over ideology, you’re going to see them borrow when it makes sense, buy back stock when it makes sense, and invest in their businesses when it makes sense. They may become the marginal “active investor” since their shareholder bases will be increasingly checked out.

-What this means is in 2020, 2025, 2030, when we have recessions and bear markets you’re going to see millions of clients of Wealthfront simultaneously logging in and clicking “sell.” Prop desks at banks will be long gone. You’ll have two main providers of capital — opportunistic CEO’s, and the remaining active managers out there, who won’t have the size that ones did in the 2000’s. We may be entering a period where ironically passive products, which ultimately free-ride off of active managers, produce low returns for a decade while active managers find their most attractive environment since the ’90s.

  1. csen posted this