A transformation in the fund industry: passive assets are overtaking active ones

A transformation in the fund industry: passive assets are overtaking active ones

The writer is the head of Meitav Ni’a

The upheavals in the local market, which also occur against the background of the promotion of the legal reform, are expressed in a series of investment avenues. Thus the shares in Israel fell strongly and show a lack of performance compared to indices in the world, the government and corporate bonds also fell, and the shekel weakened significantly against the dollar.

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These upheavals also permeated the industry The mutual funds, and this is even before the impact of the recent collapse (and possibly bailout) of several US banks and the Swiss Credit Suisse bank affair that ended in its sale to UBS.

The mutual fund industry as a whole provides investment instruments and investment solutions for a very wide variety of needs and in a very wide variety of investment avenues. Mutual funds have become a very popular investment instrument, and not only in Israel, thanks to a variety of advantages that they provide to their investors: diversification of investments and risks in a convenient way, daily liquidity, taxation advantages, professional management at a relatively low cost, transparency and more.

As a rule, it is customary to divide the industry into two main categories – active mutual funds whose managers try to achieve more than the so-called benchmark, i.e. more than the index that represents the field in which the fund specializes, and passive mutual funds, whose managers do not try or claim to achieve more than the benchmark by choosing Selectivity of stocks, but simply stick to it and copy it, and in the simplest way buy with different techniques all the stocks that are included in a certain index and with the same weight in the index.

The active industry preceded the passive industry in the US, Europe and Israel, and its origins date back to the 70s of the last century, with the founding in the US of the “Vanguard” company, which is currently the second largest in the world in the passive field. It arrived in Israel about 20 years ago in the form of the first ETF called “Psagot Tali 25”.

Later, in 2008, sisters were born to the ETFs in the form of mutual funds. Thus, while an ETF represented a commitment by the manager to the fund’s investors to achieve for them what the tracked index would achieve (the benchmark), a copy fund only promised to “try” to achieve the benchmark, without commitment.

The obligations of the ETFs to obtain the benchmark for the investors was changed by the Real Estate Authority in Israel, fearing that if the manager of the certificate fails to obtain the benchmark due to an operational or other failure, he will have to compensate the investors with huge sums that he does not have. Because of this, he It was required to present high amounts of equity, but in a way that did not really guarantee compliance with obligations in the event of a failure on a very large scale.

This was the background to the major reform that was carried out in 2018 and turned ETFs into ETFs that do not commit to achieving the benchmark, but in case it is not achieved, the fund manager is required to compensate the investors up to a certain limit and is limited between 0.1% and 0.3 % of the fund’s assets, depending on its type.

For the sake of symmetry, the fund manager can also get paid if he manages to generate a return that is higher than the benchmark return within the same limits. In such a case, the excess return and the resulting profit go to him. These are the same “variable management fees” that are added to the fixed management fees charged by the fund manager.

Lower costs for passive management

For many, many years, the active industry in Israel was much larger than its passive sister (see graph), but in recent years this gap has narrowed, due to the fact that the passive funds – the basket and the derivatives – have raised more money from the public than the active funds.

In general, in the last decade the active funds have stagnated in terms of the scope of their assets, while the passive ones have grown. The gap in assets in favor of the active funds has been closing since the end of 2017, and this is how we reached a turning point in the very last month: for the first time in Israel, the extent of the assets of traditional passive funds exceeds the assets of traditional active funds (without managed financial funds, a category that does not exist at all in passive funds): 154 billion shekels in passive funds compared to 152 NIS 1 billion in the active funds.

This is a significant change that represents the preferences of the public, and especially of the investment advisors in the banking system for a simple, highly transparent product with relatively low costs.

The reduced costs are due to the fact that managing passive funds mainly requires trading operation and risk management skills, while active funds also require high-cost investment managers.

In addition, active fund managers pay the fund distributors, the banks, a distribution fee of 0.35%. And not a one-time fee, but a continuous one (as long as the client holds units in the fund), which means that this should be the lower limit of the management fee charged by the fund manager if he does not want to lose.

On the other hand, in passive funds, things work differently. Their managers do not pay a distribution fee to the bank, which allows them to charge low management fees, and beyond that, in some products they compete for the customer against basket funds abroad, mainly in the US, where the management fees are very low thanks to their huge size advantage.

In passive funds, whether they mimic or basket funds, the customer pays buying and selling commissions to the bank, while in active funds there is no such commission, because the bank receives its commission, the distribution commission, from the manufacturer, i.e. from the fund manager.

Activities flourish on high days in the markets

The preference shown by some of the investment advisors for the passive products also stems, in my estimation, from a reduction in the number of advisors in the system and the burden imposed on them, since it is easier to choose a passive fund than an active fund. And later on, their relationship with customers is easier, especially during a crisis.

In the attached graph you can see how over the years the gap between the total assets of the traditional active funds and that of the passive funds has been expanding and shrinking. It increases in favor of the active funds when there is a tide in the stock market and decreases in times of crisis. In 2017, which was a boom year in the Tel Aviv Stock Exchange, the gap reached a peak, and since then it has been getting smaller and smaller until it reversed at the very beginning of the month as mentioned.

The active funds industry is currently at a low of nearly ten years. Its total assets are at the same level as at the end of 2013, while the stock and bond markets have risen significantly since then, and in the same time period of the last nine years, the passive industry has grown by about 70%.

Also in the world, the passive industry, which has 11,072 ETFs, is gaining momentum. If at the end of 2019 its total assets in the world reached 6.4 trillion dollars, then recently it reaches 9.23 trillion dollars, after already reaching 10.3 trillion dollars at the end of 2021. The growth stems both from an increase in value (except of course in 2022) and from the introduction of funds into the industry in The record of 2021 – raising 920 billion dollars.

The data – from the research company ETFGI and the Tel Aviv Stock Exchange – are correct as of 3/16/23. The aforementioned does not constitute advice and/or investment marketing and/or a recommendation and/or opinion and/or an offer to purchase a service that takes into account the data and needs of any person, and does not replace the reader’s independent judgment. Meitav Group may have possession of financial assets mentioned in the article


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