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More RIA Firms are Utilizing Passive (and Active) Portfolio Management

Posted by RIA in a Box

Sep 8, 2015 11:05:00 AM

Earlier this year, we surveyed over 1,000 registered investment adviser (RIA) firms about their operations, technology, and portfolio management styles, and then coupled the results with several different firm performance metrics. Previously we discussed how our survey revealed that RIA firms that aggressively adopt technology and advisory firms that offer financial planning services are growing assets under management (AUM) faster relative to their peers. This next post examines the data to answer the question: What types of portfolio management styles are RIA firms utilizing and does the style impact growth?

The chart below indicates the year over year change in portfolio management style of the firms surveyed across AUM bands ranging from $0-$25 million to firms with $100 million or more:

Summary of RIA firm portfolio management styles

Our study does show that active portfolio management is still the most common portfolio management style utilized by RIA firms at 43%, and in fact, even grew in adoption in comparison to 2013. However, at the same time, the study also reveals an increase in the utilization of passive investment management to 19% of all RIA firms. Interestingly, it appears that fewer firms compared to last year’s survey are employing a hybrid portfolio management style as more are managing portfolios with an exclusively active or passive style. It will be interesting to observe if this trend of more clear portfolio management style conviction continues in future years.

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Furthermore, looking across different AUM categories, the adoption of active and passive investment management styles appears to be fairly consistent. However, there does seem to be a fairly significant increase in the use of passive management in the $0-$25 million, $25-$50 million, and $100 million and greater AUM categories. Given that larger RIA firms tend to work with larger clients on average, it’s interesting to note that the adoption of passive management is not limited solely to smaller firms working with smaller clients but also with larger, more established firms commonly serving more wealthy clients. 

Active vs. Passive Portfolio Management Over the Years

The recent increase in the use of passive investment management style is also echoed in the table below which looks at portfolio management style given the year the advisory firm was established:

RIAActiveVsPassiveManagementStyleByYear

There does appear to be an uptick in passive portfolio management style with more recently established firms in 2013 and 2014 with rates of 22.7% and 21.9%, respectively. At the same time over the past two years, there seem to be fewer newly established RIA firms employing an exclusively active management style. Some would say that the relative increase in the use of passive investment management style for new advisory firms makes sense given the relative calm market times as of late. Thus, it may be interesting to see if more advisory firms switch to an active portfolio management style if markets become more volatile in the future. On the other hand, it's evident that more firms, of all sizes and tenure, are continuing to embrace passive investment management over time and we expect this general trend to continue regardless of market volatility.

RIA Firms Using Active Portfolio Management Have More Volatile AUM Growth

As the chart below depicts, advisory firms that manage portfolios actively seem more likely to experience both exceptional AUM growth or decline relative to industry peers:

Investment Advisory Firm Aseet Growth

Regardless of portfolio management style, the average AUM growth in 2014 of all RIA firms that we surveyed was 27.7%. The chart above buckets all firms into one of four buckets based on 2014 AUM growth:

  1. Less than 30%
  2. Between -30% and 0%
  3. Between 0% and 30%
  4. Greater than 30%

Firms that utilize passive portfolio management are fairly evenly distributed across the four buckets. We believe this makes sense given that perhaps less of the asset growth for firms that utilize passive portfolio management can be attributed to client investment portfolios out-performing. Thus, the vast majority of the relative AUM growth for firms using passive management compared to industry peers can be attributed to client acquisition and retention

On the other hand, firms using active investment management represent a disproportional percentage of the firms with AUM growth rates between -30% to 0%. Whereas around 43% of all firms exclusively utilize active management, nearly 75% of the firms with between -30% to 0% AUM growth in 2014 exclusively employ active investment management. While some of this can likely be attributed to randomness, it appears that advisory firms that manage portfolios actively may be at more risk of growing at a slower pace relative to peers due to the risk of client investment portfolios under-performing. This is a phenomenon we will look to test further in future studies.

Check back in the coming weeks as we continue to release more sneak previews from our upcoming investment adviser industry report on growth, technology, investment styles, and advisory fees. In addition, be sure to review our other recent sneak preview blog posts:

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Lexington Compliance and RIA in a Box LLC are not law firms, investment advisory firms, or CPA firms. Lexington Compliance and RIA in a Box LLC do not provide legal advice or opinions to any party or client. You should always consult your relevant regulatory authorities or legal counsel if applicable.

Topics: RIA Operations

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