Passive is massive – be responsible

As a parent of four children who are now entering their teenage years, I spend quite a lot of time educating my offspring on the asset management industry. Exhausting conversations, to say the least. One area that does resonate with them, however, is doing business for a purpose and cause, and being responsible.

The concepts of environmental, social and governance (ESG) factors and good stewardship have been a great way to introduce asset management to the younger generation, but being responsible goes further than ESG and good stewardship.

As index assets continue to grow, clients are becoming more aware of the need to partner with a manager that has their best interests in mind. A 2017 PwC report (Asset & Wealth Management Revolution: Embracing Exponential Change) puts the present day passive assets under management (AuM) at around $14 trillion. According to that same report, the number is expected to hit $37 trillion by 2025.

A growing proportion of the clients who make up those numbers are realizing there is more to selecting an index manager than simply picking the one offering the lowest headline fee. Here are some of the central tenets that we believe a responsible index manager should hold:

1. The index business should be aligned with clients’ interests
• Fund managers should be conflict-free and focus on generating the most value for investors
• Index returns are frictionless (i.e. assume no implementation costs) and as a result, pure replication will result in relative underperformance. Clients need a team that focuses on adding value in a risk-controlled manner to, at a minimum, recoup those costs
• Seek to reduce impact from affiliated service providers (e.g. in-house custodian, broker, etc.)
2. The index industry should understand its corporate responsibility
• Passive investors, but active shareholders!
• Leverage the capabilities and reach of a corporate governance team free to act independently within the organisation
3. Continue to invest in people, products and technology capable of supporting the evolving needs of index clients and support a diverse culture

Someday I hope my kids appreciate the ins and outs of synthetic exchange-traded funds (ETFs) and currency overlays, but in the meantime, being I’m happy they understand the need for the asset management industry to be responsible.