One of my first lessons in finance was that you cannot consistently outperform the market. When it does occur, it is the result of luck rather than skill. You are better off investing in passively managed funds than those actively run by gurus and clairvoyants.
Performance
According to SPIVA, research that tracks the performance of actively managed funds, 90% of funds underperform their benchmark. This has led me and an ever-growing number of investors, to invest purely in passively managed index funds or ETFs.
Fees
Passively managed funds typically charge lower fees than their active counterparts as reproducing an index is easier than stock-picking. According to Morningstar, 90% of passive funds charge an annual fee of less than 0.5%, compared to only 13% of active funds. Competition is ruthless.
Pressure
So, what does this mean for the fund industry?
The reduction in fees is going to have a cascading impact on the whole industry. The use of extensive outsourcing and delegation means that there will be less money available, not only to fund managers but also to their service providers.
To maintain their AUM, an increasing number of fund managers will launch passive strategies which is going to further accelerate the downward pressure on fees. Fees for active funds will also be reduced to compete. The industry's fee structure will be permanently affected.
AI
Apart from fees, there will be other impacts, we won’t need as many portfolio managers. Passive strategies require minimal human input and can be extensively automated by existing technologies and increasingly by artificial intelligence. AI could also threaten actively-managed funds.
Safe Havens
There are areas, such as alternative investments or niche strategies, where active management is still required and remains attractive to investors, irrespective of the fees being charged. These types of investment funds will be shielded from the downward pressure on fees.
Well, what is going to happen to us in Luxembourg?
Immune
Fortunately, there is little correlation between the fees being earned in the fund industry and the decision to establish a presence here. The main reason to be in Luxembourg is to gain access to passporting and a wide range of investment vehicles.
Our bread and butter, our main source of income, is setting up investment vehicles which can raise funds from investors of all types globally. These services are required whether the concerned investment vehicle is of a passive or active nature.
Although not impenetrable, we have built a competitive moat around our industry which will be hard for other jurisdictions to cross. This is an industry that requires a plethora of skills to be successful, we have some of the best fund professionals in the world.
Ultimately, there is a downward pressure on fees across the industry as a whole but we are relatively immune to the consequences locally. We should not become complacent though, this trend will force investment firms to look at their costs, and our charges will eventually be scrutinised.
To maintain our margins, we need to pull up our socks and become more efficient.
Gregory Kennedy is a columnist for Investment Officer Luxembourg. His columns appear on Wednesdays. He also works as a business development manager at Finsoft Luxembourg.
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Earlier columns by Gregory Kennedy:
- You cannot excel with Excel
- Column: Attracting talent is getting harder!
- Column: Costly outsourcing is not the solution
