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Is Bigger Better If Active Managers Want To Fight Passive Managers?

Image via Markus Spiske on Unsplash

Active management, aka active investing, is a strategy where an individual picks specific investments with the goal of outperforming a benchmark or target return. Conversely, passive management, aka passive investing, is a strategy that tracks an index or portfolio. Proponents of passive management cite low fees, low turnover and diversification as some of the benefits of this strategy.

The last decade has been tough on active management, with countless articles detailing the strategy's troubles. Last August, assets in passively managed U.S. equity mutual funds and ETFs exceeded those in actively managed stock funds for the first time.

Every $100 of assets will cost you an average of about $0.10 per year for passively managed U.S equity funds, compared to an average of about $0.70 per year for actively managed funds. 

"That represents investors keeping more of their own money," said Eric Balchunas, a Bloomberg Intelligence analyst. "If there’s a loser in this, it’s probably the asset-management industry. The rise of passive represents the rise of very low fee products and ultimately that’s going to mean some pain for them."

Yesterday brought an announcement that two of the largest active managers will combine to compete in an increasingly passively managed world. Franklin Resources announced it will acquire Legg Mason for $4.5 billion in an all-cash deal, creating an investing behemoth with $1.5 trillion in assets under management (AUM).    

"This is a landmark acquisition for our organization that unlocks substantial value and growth opportunities driven by greater scale, diversity and balance across investment strategies, distribution channels and geographies," said Greg Johnson, executive chairman of the Board of Franklin Resources. 

The combination of Franklin Resources, which has $698 billion in AUM, and Legg Mason, which has $803 billion in AUM, will create one of the world's largest asset managers. The combined entity will be in a better position to compete with industry giants such as BlackRock, Vanguard and Fidelity. 

Nelson Peltz, CEO of activist investor Trian Fund Management, which owns a 4.5% stake in Legg Mason, agrees the deal helps Legg Mason better compete in a rapidly changing environment. "Given the dynamics of today’s rapidly evolving and increasingly competitive asset management sector, I believe this transaction is compelling," Peltz said. "I believe it will also enable Legg Mason’s investment affiliates to remain at the forefront of an industry where scale is increasingly vital to success and to join Franklin Templeton." 

Financial services companies continue to face intense competition. The brokerage industry has also shown mergers may be the best way to remain competitive. Amidst the race to cut trading commissions to zero, Charles Schwab acquired TD Ameritrade last year. Last month, Visa acquired fintech startup Plaid in a move that was widely seen as protecting itself from an up-and-coming competitor.

As assets continue to move to passive investing strategies, active managers will likely have to continue to merge in order to remain competitive in a quickly changing industry.

Leftover Crumbs

  • A complete overhaul. HSBC, Europe's largest bank by assets, announced a major overhaul that will see 35,000 employees lose their jobs over the next three years. The bank will also shrink its investment banking division, merge its private banking and wealth units, end European stock trading and close about a third of its U.S. branches. HSBC will halt share buybacks for two years while maintaining its dividend. HSBC expects to incur restructuring costs of approximately $6 billion between this year and next.

  • Starting to lose track of all the issues. Another day, another Boeing embarrassment. According to an internal memo, Boeing found debris in grounded 737 MAX airplanes awaiting delivery that could pose a safety threat. Foreign object debris is an industry term for "rags, tools, metal shavings and other materials left behind by workers during the production process." The general manager of the 737 program said the findings were "absolutely unacceptable." A Boeing spokesperson confirmed the memo's authenticity but downplayed it, saying the company does not see the issue as delaying the airplane's return to service.

  • Salty much? Microsoft co-founder Bill Gates has struck a chord with Tesla co-founder and CEO Elon Musk after saying in an interview that he recently purchased Porsche's new electric vehicle, the Taycan. "I have to say, it’s a premium-price car but it is very, very cool," Gates said about the Taycan. "That’s my first electric car and I’m enjoying it a lot." Musk, replying to a tweet about the interview, responded "My conversations with Gates have been underwhelming tbh."

  • Gotta talk about both sides of the trade. A group of professors has asked the U.S. Securities and Exchange Commission to require individuals who publicize a short position in a security to also disclose when they cover their short. "The commission should vigilantly ensure that short position disclosure, when voluntarily initiated by a short seller, remains truthful and accurate," the professors' petition read. "When a short seller has chosen to disclose a short position, failure to disclose that the position has been closed is doubly misleading." An SEC spokesperson declined to comment on the professors' letter.

  • Dairy Farmers of America to the rescue. Dairy Farmers of America has agreed to acquire Dean Foods, the largest milk producer in the U.S., for $425 million. Dean Foods filed for Chapter 11 bankruptcy protection in November as the milk industry continues to fight declining consumption. The acquisition will need approval from the Department of Justice, which has reportedly begun probing the deal. "We have had a relationship with DFA over the past 20 years, and we are confident in their ability to succeed in the current market and serve our customers with the same commitment to quality and service they have come to expect," Dean Foods CEO Eric Beringause said.