Passive investors could have the assumptions kicked out from under them by technology, according to Hamish Douglass, head of Magellan Asset Management.
In a newsletter marking the 10th anniversary of the wildly popular Magellan Global Fund, Douglass says the ability of index investing to provide “reliable absolute returns” to date has rested on two fundamental conditions: a “fairly constant” long-term price/earnings (P/E) ratio for most stocks in the index, and; a “fairly static” failure rate of companies in the index.
“Historically, these premises have held for the major market indices and investors have achieved satisfactory returns from index investing,” he says in the newsletter. “In our opinion, there is a material risk that technological advances and business-model disruptions over the next 10 to 20 years will reduce the value of many companies in the major market indices.”
Under that scenario passive investors would face lower returns as the value of indices plummet.
Douglass says “a meaningful proportion” of companies would be driven to extinction over the next 20 years as technology overwhelms current business models.
Diverse industries including oil, car manufacturers, coal miners, media firms and retailing were vulnerable to technological disruption, Douglass says.
“Additionally, a large proportion of businesses could have their business models fundamentally disrupted over the next 10 to 20 years,” he says. “In our view, many of the large consumer brand companies could be vulnerable.”
For example, Douglass says online retailing giant Amazon is well-placed to white-ant the world’s largest household products firm, Procter and Gamble (P&G).
“We believe that for many of P&G brands (like cleaning agents Tide, Fairy, Dawn, and for products like paper towels (Bounty) and toilet paper (Charmin), it will be relatively easy for consumer platforms to disintermediate these products over time and replace them with, say, Amazon-branded products,” he says.
However, investors needed to carefully examine underlying business models of techno-disrupters rather than falling for the hype, Douglass says, citing Uber as a losing bet.
“In our view, looking in the rear vision mirror will tell you little about which businesses will do well in the future,” he says. “It is more important than ever to look out the windshield and think about how technological changes could alter business models in the future.”
In spite of his doubts about the viability of indexing in an up-teched world, Douglass says Jack Bogle, the Vanguard founder considered the godfather of passive investing, “deserves the investment equivalent of a sainthood”.
“Bogle is a hero of mine for the service he has done for society by lowering the cost of accessing the market index to negligible levels,” he says. “I have named the office adjacent to my desk (open plan) the ‘Bogle room’ in honour of Jack. It serves to remind me that we are here to serve our clients and, as active managers, we must do something fundamentally different, rather than mimic or closely follow the market index.”
As at July 1 the Magellan Global Fund reported funds under management (FUM) of almost A$9.2 billion.
Across all its products, the ASX-listed Magellan recorded FUM of about A$50.6 billion at the end of June – down from A$52.2 billion a month earlier. According to an ASX release, Magellan has sourced almost $17 billion for its global equity funds from Australasian retail and institutional investors with well north of $1 billion understood to have come via NZ clients.
“Magellan is entitled to estimated performance fees of approximately $18 million for the six months ended 30 June 2017,” the ASX note says.