This is the second of a series of blog posts in the coming weeks that provide select insights from our 2015 Registered Investment Adviser (RIA) Industry Overview Report that will be released later this summer. This proprietary RIA in a Box study used detailed survey responses from 1,198 advisory firms paired with publicly accessible data provided on the Securities and Exchange (SEC) website.* The goal of this annual study is to understand different options that comprise each firm characteristic, and to determine whether specific characteristics affect the growth, size, or operational efficiency of an RIA firm.
Portfolio Management Style
RIA firms determine whether to manage client investment portfolios with an active, passive, or hybrid management style. An active approach generally implies buying and selling securities with the intent of outperforming an investment benchmark index. A passive approach generally implies utilizing index funds or similar investment vehicles such as exchange-traded funds with the intent of mirroring an investment benchmark index. Hybrid firms, in regards to portfolio management style, are not absolute in their investment philosophy and may offer a mixture of passive and active portfolio management solutions to their clients (e.g. a core and satellite investment strategy).
Our survey results uncover clear trends on a number of dimensions regarding each investment management style. Most interestingly, the percentage of firms with a passive approach has grown from 14% in 2013 to 21% in 2015:
Interestingly, firms that indicated an exclusively passive investment style were also more likely to report higher assets under management (AUM) growth compared to firms that use an exclusively active investment style.
As both charts above depict, there appears to be a steady move towards more passive investment management styles over the last few years. Many firms migrating to a more passive portfolio management style point to delivering a better client investment experience and improving operational efficiency benefits as key motivations. Advocates for passive portfolio management argue that such an approach allows an RIA firm to reduce complexity and increase scalability while often reducing performance volatility risk for its clients. It's also interesting to note that as the chart above indicates, firms that employed an exclusively passive portfolio management style did experience significantly higher AUM growth rates compared to their peers during the 2015 calendar year.
It is also evident, however, that many RIA firms that employ an active portfolio management strategy continue to thrive. As such, we do not believe there is a right or wrong portfolio management style. However, as the RIA industry continues to mature, it does appear that firms will continue to steadily migrate to passive portfolio management styles. Lastly, many industry observers believe that the new Department of Labor (DOL) fiduciary rule may also be an additional impetus to drive more of the industry towards a passive portfolio management style.
Be sure to also check out last week's post comparing 2014 and 2015 AUM growth rates for RIA firms.
Note 5) The average investment advisory fee charged by the RIA firm may not include additional underlying investment manager or product fees.
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.