☀️☕️ Passives >> Actives

📝 Focus

• Passives >> Actives

📊 In the Markets

• HK China rebound; TSMC drops and beats; Indo-BYD?; Robinhood Addiction

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• 🎓 Passive Funds

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• Exploring Your Financial Options: Why Loyalty to One Adviser May Not Be Best

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Passives >> Actives

Passively managed mutual funds and passively managed exchange-traded funds (ETFs) in the US have surpassed their actively managed counterparts for the first time, holding approximately $13.3tn in assets compared to just over $13.2tn for active funds at the end of December, according to a new report by Morningstar. 

Passive funds 🎓 attracted $529bn in net inflows last year, while active funds saw a net outflow of about $450bn. This shift has been evolving for years, starting with Vanguard's launch of the first index mutual fund in 1976. Although active assets still make up around 70% of the market when considering alternative investments, passive strategies, especially ETFs, have seen steady growth. 

Despite actively managed ETFs attracting new investments, index-based funds continue to form the core of most portfolios. The trend underscores the growing preference for replicating benchmark performances over beating them, which is a massively important shift in investors’ mindsets. 

(A recent PwC report claimed that one in six asset management groups, not just their funds, will likely disappear from the market by 2027 - see MFM: Active Fundpocalypse?.)

..... ▷ While a higher fee structure is a major factor, the underperformance of active managers over the long term is not solely due to that.

Reports by S&P Global, which compiles the excellent SPIVA (S&P Indices Versus Active) reports, show that active managers have indeed historically had higher costs than passive managers, which has been a significant contribution to their underperformance rates. 

But the S&P researchers also “argue that many active managers do not have the skill to beat their benchmarks consistently that they may claim to have. It is difficult to time the market with consistent success, and the trading costs associated with excessive trading from active managers do not help fund performance.”

This makes it exceptionally challenging for active managers to consistently beat their benchmarks, even without the fee drag.

..... ▷ One argument in favour of actively managed funds, especially those focused on large stocks in liquid and well-covered markets* is that they will outperform robotic, unmanaged funds in a volatile market. 

Covid-19 gave us an opportunity to test that theory: 2020 and the first half of 2021 were exceptionally volatile markets in which stockpickers and market timers had the chance to show their worth and earn their massive fees.

But according to Morningstar, of nearly 3,000 active funds, only 47% survived and outperformed their average passive counterparts (not even the benchmark index) in the 12 months through June 2021.

Better than most years and much better than the record over 5, 10 and 20-year periods, but still no better than a coin-flip (actually, slightly worse.)

Studies by both Morningstar and S&P Global come to the same conclusion: active management did not outperform passive, indexed strategies in volatile markets. 

While active funds may outperform passives in certain market conditions, potentially when markets are in a short-term uptrend, the probability of active funds outperforming passive funds is low over the long term, when markets have historically trended up.

The most recent short-term uptrend wasn’t too encouraging either, though. In 2023, when the S&P 500 shot up 24.2%, only 38% of large-cap actively managed funds outperformed their Russell index benchmarks.

(*Alternative assets and less liquid stocks etc., are another story entirely.)

..... ▷ BUT there are potential downsides as markets get more and more heavily indexed, including but not only the following:

• Overvaluation of popular stocks: Passive funds follow major indexes, which can lead to the overvaluation of popular stocks within those indices, potentially inflating bubbles and distorting true market value.

• Under-pricing of hidden gems: Smaller, less-followed companies with potential may get neglected, hindering efficient capital allocation and innovation.

• Reduced market resilience:

• Herd behaviour: Large inflows and outflows from passive funds can create a herd mentality, amplifying market swings and potentially exacerbating crashes.

• Limited alpha generation: Fewer active managers searching for undervalued assets could end up leading to a decline in overall market returns.

• Reduced shareholder engagement: Passive investors may be less likely to actively engage with companies on issues like governance and sustainability.

• Price discovery: Some argue that active investors play a crucial role in uncovering undervalued assets and correcting mispriced securities, ensuring efficient price discovery in the market.

• Innovation: Without active investors searching for promising small companies, the potential for innovation and future market leaders might be stifled.

🇸🇬 Singapore: Let’s Get MoneyFitt!

📊 In the Markets

Hong Kong and mainland shares rebounded (finally) on Thursday, with China’s CSI 300 index of Shanghai and Shenzhen shares gaining 1.4% and Hong Kong’s Hang Seng index climbing 0.9%. Europe was up a bit after three negative sessions, with the benchmark indexes of all five major markets, London, Frankfurt, Paris, Milan and Madrid, ending in the black.

But US stocks surged, with tech propelling the S&P 500 toward record highs, driven by AI optimism benefiting chipmakers like Nvidia. US-listed shares of TSMC (see below)  saw a nearly 10% rise after projecting strong growth in 2024 on robust demand for high-end AI chips. AI leaders Nvidia and AMD both hit record highs on huge volumes. Broadcom, Qualcomm, and Marvell each gained over 3%, helping the SOX, the Philadelphia SE semiconductor index, up 3.4% to close on its December 2023 record high.

Traders largely ignored data on fewer US job losses (new unemployment benefit claims), which suggests a strong labour market and a strong economy, which pushes out the likelihood of springtime rate cuts that markets have been pricing in since late November. 

Taiwan Semiconductor Manufacturing Company (TSMC), the world’s largest contract chipmaker, or “foundry”, reported better-than-expected profit and revenue, though still down 1.5% and 19.3%, respectively, amid weak macroeconomic conditions and an oversupplied semiconductor market. 

Revenues this year are expected to surge by 25% as the semiconductor industry pulls out of a deep trough, led by strong AI chip demand. TSMC is benefiting from the ramp of its industry-leading 3-nanometer technology, with 2-nanometer coming next year, making it a major player in AI semiconductors. Overall, industry revenues are expected to grow only 10%.

TSMC's notable clients include Nvidia and AMD as well as Apple (which was up 3.3%, its biggest daily gain since May), for whom it produces the most advanced iPhone processors, all of whom are “fabless” (meaning that they don’t have any chip manufacturing capabilities themselves.)

BYD will invest $1.3bn in an Indonesian electric vehicle factory, aiming to become the country’s top EV brand. This would be the Warren Buffett-backed Chinese carmaker's sixth overseas auto plant, a global expansion strategy amid growing protectionism against Chinese products in Western markets.

BYD also happens to be one of the world’s biggest EV battery makers, and nickel is an essential raw material. As Indonesia holds the world’s largest nickel reserves, it stopped exports of nickel ore in 2020 to attract automakers to create an EV ecosystem.

Robinhood will pay a $7.5mn fine for its use of "gamification" to encourage trading while ignoring controls to safeguard inexperienced investors. It used standard tactics lifted wholesale from the gamification playbook, like animated confetti and balloons and features resembling games of luck to “attract and manipulate users”. 

These fire up the same reward and anticipation neurotransmitter that helps drive addictions like gambling, doing drugs and watching porn. The reward centre in the brain releases dopamine in response to pleasurable experiences, which creates a strong memory of the pleasure felt and prompts the individual to seek out similar experiences over and over and over again.