Investors Continue Moving to Passive Management

Last Updated Aug 1, 2011 11:12 AM EDT

Despite more than 50 years of academic research providing an overwhelming body of evidence that passive management (including indexing) is the winning investment strategy, the majority of dollars are still invested in actively managed funds. Unfortunately, this choice costs tens of billions of dollars a year in lost returns.

However, there's good news. Demonstrating that you can't fool all the people all the time, there's a powerful trend toward passive investing. The following table provides the market shares of passively managed vehicles (ETFs and index funds) and actively managed funds for 2001 and 2010. Data is from Morningstar and State Street.

In the 10 years from 2001 to 2010, the combined market share of the two passive vehicles increased from 11.3 percent to 25.5 percent. That's a relative increase of 126 percent. Active funds saw their market share fall 12.2 percent, a relative drop of 14 percent.

The Investment Company Institute's 2011 Investment Company Fact Book reports that there's about $13 trillion in mutual fund and ETF assets. A 12 percent shift in market share means that there's now $1.6 trillion more in passive vehicles than there would have been if the market shares had remained unchanged from 2001. If we assume that the average active fund underperforms its passive benchmark by even 50 basis points per year, the result is that investors are saving an extra $8 billion a year.

The trend toward passively managed funds continues in 2011. In June, while actively managed funds experienced net outflows of about $19 billion, passively managed funds actually had inflows of over $1 billion. Morningstar noted that "that some of the funds taking the worst lumps are a who's who of active management." Several prominent funds saw tremendous outflows, including:

  • American Funds Growth Fund of America (AGTHX)
  • Fidelity Magellan (FMAGX)
  • Davis NY Venture (NYVTX)
  • Fairholme (FAIRX)
That's the good news. The bad news is that a large majority of dollars are still invested in active strategies. That means tens of billions of dollars are dollars are being lost annually in a triumph of hope, hype, and marketing over wisdom and experience. Fortunately, there's hope for those who are still blinded by the marketing hype of Wall Street and much of the financial media. As Victor Hugo, nineteenth century French novelist noted, "There is one thing stronger than all the armies of the world, and that is an idea whose time has come."

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    Larry Swedroe is director of research for The BAM Alliance. He has authored or co-authored 13 books, including his most recent, Think, Act, and Invest Like Warren Buffett. His opinions and comments expressed on this site are his own and may not accurately reflect those of the firm.