“What is ironic is that active managers have been doing exactly what they needed to do to fight back, and it still hasn’t helped much. It might even be hurting,” says a recent Bloomberg article.

The article outlines steps that active managers have taken to combat the exodus to passive investing:

• Fee reduction— According to Morningstar, “investors now pay half as much to own U.S. mutual funds as they did two decades ago. But with zero commissions on share dealing now common, fee reductions haven’t helped much, yet.”
• Avoiding “closet indexing”—Active managers are reportedly moving toward more concentrated portfolios that deviate more from their benchmarks which, the article notes, “works when their bets are on the right stocks.”
• Reduce churn—Active funds tended to trade a lot, which incurred extra fees and resulted in inconsistency.

“All this should be good,” the article notes, but adds that problems arise because by holding on to bigger positions, active portfolios become exposed to the momentum factor—“the tendency for winners to keep winning and losers to keep losing.” While over time this has led to big gains, the article argues, over time the winning stock will take up an increasingly significant proportion of the portfolio and make the fund more exposed to momentum and, consequently, more vulnerable to a crash.

The article notes that although recently active managers have generated gains, it may be due to a “brief but successful bet on the dominant internet names “and an “unsuccessful bet” that interest rates would rise.

“But now,” the article concludes, “we have returned to a falling rates environment. And active managers have returned to playing a loser’s game.” It argues, however, that this is attributable entirely to passive investing: “Active managers could at least review their portfolios regularly to check that they aren’t over-exposed to momentum, and to hedge against falling interest rates.”