Warren Buffet recently was asked what he wants done with his money after he dies. The answer: "Put 10% of the cash in short term government bonds and 90% in a very low cost S&P 500 index fund." He is not the only investor moving in that direction. Hedge funds and private equity groups are continuing to expand due to their unique characteristics. But conventional actively managed funds are losing market share at a fast pace to "exchange traded funds" (ETFs) and other indexed products. Costs are lower. Performance is at least as good.
The development of "smart beta" ETFs is providing an additional twist. Most index funds are weighted according to each company's market capitalization. When a stock goes up it becomes more important, and vice versa. The basic math leads to buying high and selling low. Smart beta funds weight their component stocks by sales, assets, profitability, volatility, or some other metric. The idea is to create a value driven methodology, like some active managers use, except on an automated basis with lower expenses.
Government regulations in Europe are starting to drive down expense ratios, too. Several countries have established a cap on pension expenses, driving trustees away from actively managed funds. Another reason to consider ETFs is that active fund managers in the U.S. tend to be "closet indexers." Their funds' performance closely tracks a particular benchmark. In the 1980s an estimated 70% of all mutual funds had portfolios that diverged significantly from the major market indexes. Today, just 20% do. Those are the funds that can beat the market, if they know what they're doing.
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