High fees and poor performance are a toxic combination for
actively managed funds. According to our research, the largest
active U.S. mutual funds investing in European stocks
underperformed the STOXX Europe 600 index by 17 percentage
points on average over the past 12 months. A failure to
generate alpha is among the key drivers behind the emergence of
index investing, which, in turn, is raising questions about the
relevance of active managers investing in Europe.
A lack of investor conviction in portfolio managers
ability to beat the market has sparked a shift toward passively
Exchange-traded funds have enjoyed a wave of popularity
since the 200809 financial crisis, and last year
saw the highest amount of inflows to Europe to date.
Projections show that this record will be broken again this
year, with the European ETF industry on track to
reach $500 billion in the coming months.
Strategies tracking an index are attractive to investors for
two reasons. First, index funds have lower fees, typically
around 0.50 percent of invested client money. Second, European
markets have rallied significantly in the years since the
recession. During the past two years, the Euro STOXX 50 index,
which includes the largest European stocks, gained 39 percent.
This level of performance has lured more investors into cheaper
It is perhaps not surprising, then, to see very significant
demand for U.S.-based indexed funds, including ETFs and mutual
funds, investing in Europe. Since June 2014, such funds have
seen inflows of $24.6 billion, according to Lipper and Nasdaq.
At the same time, there has been a growing aversion to actively
managed funds. From September 2014 to January 2015, investors
withdrew an aggregate $4.4 billion from actively managed funds
focused on European stocks.
Yet economic and political shocks could apply the brakes to
this trend and reverse it rapidly. A recent survey from
PricewaterhouseCoopers indicates that an extreme market event
could highlight the risks associated with ETFs and dampen
European markets are not immune to such a reality check. For
one thing, debt-to-GDP ratios in France, Spain, Italy and
Greece stand at 95 percent, 97 percent, 132 percent and 176
percent, respectively. Speculation about a Greek exit, or
Grexit, from the euro zone, has risen sharply along with the
risk of default, which will come to pass if the country
doesnt get another bailout extension at the end of June.
populist, euroskeptic political parties are gaining
traction in a number of European countries. A recent poll
showed that Marine Le Pen, leader of Frances
ultranationalist party, Front National, would win 30 percent of
the vote in the next French presidential election. Should
euroskeptic parties continue to gain power, it could have
adverse effects on European financial markets.
Actively managed equities can prevent significant losses of
capital, among other things. By choosing to diverge from
underlying indexes, active managers can construct portfolios
that may be less sensitive to economic and geopolitical events
and are better able to protect investors during volatile times.
Equities that exhibit a low or negative correlation to European
indexes such as the STOXX Europe 600, which passive funds tend
to replicate, fare better during sharp market declines.
The simplest way to measure a portfolios potential to
safeguard investors is to identify its active share, or the
degree to which a funds portfolio differs from that of
its underlying index. Mutual funds are increasingly disclosing
The current environment may present an opportunity for
active management to regain some ground in Europe. The
correlation among the 50 European biggest stocks fell by 12
percent from November 2014 to January 2015. Moreover, the
VSTOXX, which measures the volatility of the Euro STOXX 50
index, has bounced back from yearly lows in June 2014. A
decrease in correlation coupled with an increase in volatility
provides a chance for active managers to outperform their
Its prime time for asset managers to underscore their
value proposition to clients. Investors are watching.
Nicolas Hourcard is a European equities analyst with Nasdaq Advisory Services in
The opinions expressed in this article are those of the
author and dont necessarily reflect those of
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