Wall Street’s Eternal Debate: Active Managers Fight for Relevance as Passive Funds Eat Their Lunch

Hedge funds and pension giants are still wrestling with the active vs passive dilemma—despite decades of data showing index funds win long-term. The latest consultant reports reveal institutions pouring another $47B into passive strategies last quarter while active managers cling to their 2-and-20 fee models.

Why the disconnect? Three brutal truths:

- Performance chasing: That one star PM who beat the S&P 500 three years straight still gets allocations (until they don’t)

- Consultant incentives: Nobody gets fired for recommending Vanguard—but where’s the fun in that?

- The ’smart beta’ illusion: Quant teams rebranding closet indexing as something revolutionary

Meanwhile, crypto-native institutions laugh from the sidelines—their portfolios auto-rebalancing via smart contracts while traditional finance argues over basis points. Maybe the real active management was the friends we overpaid along the way.

Most institutional asset owners currently are using passive investments or have Leveraged passive investments in the past. However, they remain split on whether active or passive management offers the best risk/return profile for public market exposure, according to the latest Cerulli Edge—U.S. Institutional Edition.

Cerulli’s research shows more than half of institutional asset owners (57%) say they will use investment strategies that can offer the best risk/return profile regardless of whether it is an active or passive approach. Meanwhile, 30% of asset owners prefer active strategies, while another 29% prefer passive strategies.

For those that prefer passive strategies, cost is often a reason why, with 25% saying they invest in active only in certain asset classes because of their higher cost. Asset owners tell Cerulli they have sought out passive in public equity markets to minimize their risk exposures in that portion of the portfolio and to maximize their risk budgets for higher-cost alternative strategies. Others use the more predictable, pure-play exposures that indices can provide for tactical purposes in their portfolios, such as addressing gaps in portfolio allocations and making directional bets.

Across all institutional channels, the majority (75%) of asset owners report using passive equity exchange-traded funds (ETFs), with that percentage exceeding 90% for public and corporate defined benefit plans and nearly 90% for endowments and Taft-Hartley plans (89%). Looking ahead, nearly 40% of asset owners tell Cerulli they plan to increase their use of the ETF vehicle, the highest percentage of any vehicle in Cerulli’s survey.

While allocations to passive investments may fluctuate, institutional asset owners view them as a critical tool for achieving their investment objectives.

“For asset managers offering passive strategies, a clear opportunity exists to continue to capitalize on their use by emphasizing the low-cost nature of passive strategies relative to active strategies,” says Brendan Powers, director. “While significant demand still exists for active managers, they need to be best of breed if in an asset class in which passive will be sought after (e.g., large-cap equities); otherwise, they may be in an uphill battle to find winnable mandates,” he concludes.

Source: Cerulli