Passive investing has experienced growing popularity over the last two decades, aided partially by the faster and more efficient dissemination of information. To this end, efficient market purists continue to hold firm to the view that there is little value in active management, given that markets are efficient and security prices reflect available relevant information. In this commentary, we share our thoughts on this perennial debate between active and passive investing, and suggest that the case for active investing remains very much alive here in Asia.
Winds of Change
Efficient market purists have always believed that there is no value to active management on the back of the view that markets are efficient, with security prices reflecting available relevant information. Hence, as prices reflect their supposedly true value, it does not seem like active management can add any value since it involves finding and taking advantage of mispriced information, in a bid to construct a portfolio that can outperform the market. And this is even before we take fees into consideration!
In view of the above, passive investing which involves replicating the market or an index centred on efficient market theory, has indeed gained popularity in recent times. According to a recent report by Bank of America, passive fund assets now account for 47% of total equity assets under management and are expected to surpass active equity fund assets by August 2021.
The advent of technology has certainly played a big part in the rising popularity of passive investing, amid the faster and more efficient dissemination of information. Information can easily be obtained with a click of the mouse or a swipe of the finger on a device nowadays. Additionally, technology has also facilitated for the mass creation of investment products, especially passive ones like Exchange Traded Funds and Exchange Traded Notes.
Equity Fund Assets: Passive versus Active
Source Date: 30 August 2020
Equity Fund Assets: US and Asia ex Japan Equities Fund Flow
Source Date: 4 August 2020
Morgan Stanley also goes on to show that investing in the US via the MSCI USA index, since 2005, would have generated 8.6% in annualised returns, coupled with a Sharpe Ratio of 0.48. It is worth noting that both these characteristics surpass those that would have been generated from investing in Asia via the MSCI Asia Pacific ex Japan or MSCI Asia ex Japan indices over the same period. This said, the conclusion reached is however very different when we consider investing in either market via the application of an active management investment approach.
Equities Performance in Asia vs US since 2005
Source Date: 4 August 2020
Aggregated after-fee relative returns of Active vs Passive funds in Asia and US
Source Date: 30 August 2020
Here, data obtained from Morgan Stanley indicates that active funds have outperformed passive funds here in Asia ex Japan, after adjusting for fees. This differs from the case in the US wherein the aggregated after-fee returns of active funds relative to passive funds is negative.
Active managers in Asia have delivered about 8.8% in annualised, after-fees adjusted returns since 2005, thus outperforming both passive funds and the benchmark MSCI Asia ex Japan Index, with a superior Sharpe Ratio of 0.43. On the contrary, US active managers have underperformed both their passive fund counterparts and the benchmark MSCI USA Index over the same period.
Performance of Active and Passive Funds in Asia ex Japan and the US Since 2005
Source Date: 4 August 2020
Dominant Stock Specific Returns and Greater Opportunity Set in Asia
Analysing the composition of returns in both Asia and the US, stock specific factors appear to have contributed more of the total returns in Asia than in the US. Since 2005, 63% and 71% of returns from the MSCI Asia Pacific ex Japan Index and MSCI Asia ex Japan Index, respectively, came from stock specific returns, unlike in the US where only 43% of MSCI USA returns were from stock related factors, with market or macro factors being more dominant.
Return Contributions by Market and Stock-Specific Factor in Asia and US Equities
Source Date: 4 August 2020
Return Dispersion in US and Asia ex Japan Equities
Source Date: 4 August 2020
While the greater presence of stock specific return drivers brings with it a broader and deeper opportunity set here in Asia, we should bear in mind that this in turn also causes Asian equities to generally exhibit higher dispersions and volatility. As an active bottom-up investor based here in Asia, we find such market attributes providing us with ample opportunity in our search for undiscovered idiosyncratic alpha still very much present here in the emerging markets of Asia.
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