Wealth pros warming to passive

ORLANDO, Fla. — Passive investing is gaining favor among wealth managers, according to bankers, vendors and industry consultants. “We’re seeing more of it, and there will be more to come,” said Dave Hanson, the new president and chief executive of Lancaster, Pa.-based Fulton Financial Advisors. He urged wealth managers to “embrace” passive investing during the opening general session at last week’s annual Wealth Management and Trust Conference here. The event is sponsored by the Washington-based American Bankers Association. “It’s a huge trend, and it’s particularly compelling in the high-net-worth market,” Jamie McLaughlin, New York-based managing director for Lydian Wealth Management Co. LLC of Rockville, Md., said in an interview. Lydian Wealth Management is a subsidiary of Palm Beach, Fla.-based Lydian Trust Co. Although passive investing strategies, such as index funds and exchange traded funds, are growing rapidly among wealth managers, Richard Iwanski, a partner at Capital Market Consultants LLC, a Milwaukee-based open-architecture platform provider, estimated that active equity investing still accounts for at least 75% of the market. “Passive still has a long way to go,” he said in an interview. Industry observers, however, say that the strategy, which is designed to match a market and not beat it, is growing among wealth managers at both large and small banks. The concept was popularized by John Bogle, founder of index fund giant The Vanguard Group Inc. of Malvern, Pa. About 60% to 70% of his clients are invested in “primarily passive” investment vehicles such as ETFs and Vanguard index funds, Matt McGuire, vice president of Oklahoma City-based Heritage Trust Co., said in an interview. And at San Francisco-based Wells Fargo & Co., Ron Florence, director of asset allocation and investment strategy for the bank’s wealth management group, said he also has seen more demand for passive investment strategies. The low cost of passive investments and the high difficulty of consistently beating the market appear to be the primary reasons for the surge of interest in passive investing. “If you believe the markets are reasonably efficient and that at least six out of 10 active managers won’t outperform the market, then you want to at least get your client beta, especially if your exposure to an index fund is eight or nine basis points, versus 1% or more for active managers,” Mr. McGuire said. Although technically defined as a measure of the volatility of a portfolio compared with the market as a whole, the term “beta” was used by him and others at the conference as shorthand for matching certain market benchmarks, such as the Standard & Poor’s 500 stock index. In fact, a pervasive theme at the conference was the difficulty of achieving “alpha,” or an asset manager’s ability to produce returns above an overall market’s average or a particular benchmark. “Be wary of beta disguised as alpha,” warned Manju Lind, a sales strategist for San Francisco-based Barclays Global Investors, speaking at a conference session titled “Separating Alpha and Beta: Balancing Risk, Return and Cost.” “Great active managers exist, but they’re very hard to find,” she said. “Alpha isn’t just lying around,” Mr. McLaughlin said. Others at the conference said they felt that the growing influence of the baby boomers helps explain the increasing popularity of passive investing. Baby boomers are gripped by a “psychology of uncertainty,” said Madelyn Hochstein, president of DYG Inc., a market research firm in Danbury, Conn., said in an interview. As a result, she said, “it’s not surprising that the search for risk reduction is up.” Additionally, baby boomers are being drawn to passive investing because, as they near retirement, they want to spend more time on quality-of-life and legacy issues, and less time worrying about investments in a volatile stock market, Charles “Chip” Roame, managing principal of Tiburon (Calif.) Strategic Advisors LLC, said in an interview. “More conservative strategies, more indexing and more annuitization frees them to do other stuff,” he said. Nonetheless, moving wealth management clients — and advisers — toward passive investing is hardly a slam-dunk, industry observers say. “It can be a hard sell,” Scott Welch, senior managing director of investment research and strategy for Fortigent Inc., a Rockville, Md.-based platform provider, said in an interview. “There are advisers out there who think a client will say, ‘Why should I pay you a fee if you’re just putting me in passive investments.’ They feel pressured to emphasize active strategies, because they’re still selling performance instead of advice, but at the end of the day, selling performance is a losers’ game,” Mr. Welch said. “The challenge is to communicate the rationale for including passive strategies in a portfolio, particularly in those sales-oriented organizations which have prided themselves on bringing alpha- oriented managers to clients in the past,” Mr. Iwanski said. Or, as Mr. McGuire put it: “This is different from what the clients have been hearing for the last 20 years.”