The Economist

S

INCE 1975 when the first retail invest-

ment fund that aimed simply to mimic a

stockmarket index was launched by Van-

guard such “passive” funds have squeezed

margins and profits right across the asset-

management industry. On August 1st that

trend reached its logical endpoint with the

launch of two zero-cost tracker funds by Fi-

delity a Boston-basedfirm built on active

investing that isthe industry’sfourth-larg-

est with $2.5trn under management. With

no minimum investment required and an

expense ratio (that is net cost to investors)

of zero it will further shake up an industry

that was already undergoing a major struc-

tural shift.

Fidelity’s competitorsimmediately felt

the heat. Shares in BlackRock the world’s

largest asset manager and largest provider

of passive exchange-traded funds (ETFs)

closed 4.7% down on the day as share-

holders digested the implications for its

business model. Those in Invesco the

fourth-largest ETF provider dropped by

4.2% and those in State Street (which

though the third-largestETFprovider also

has many business lines besides asset

management) by 1.2%.

Competition had already driven char-

ges on index-tracking mutual funds and

ETFs to very low levels. Fees for the index-

tracking mutual funds at Vanguard and

Charles Schwab most similar to Fidelity’s

new offerings are just 0.14% and 0.09% re-

spectively. TheETFversions of those funds

cost even less at 0.04% and 0.03%. There

are economies of scale in index investing

since costs do not rise in line with assets

under management.

Without skimming any explicit fee

from the new funds Fidelity will have to

find other ways to make money such as by

lending shares to short-sellers for a consid-

eration. It may also see the new funds as

loss-leaders hoping that investors will

eventually migrate to its other offerings. To

make that more attractive it has cut fees for

its existing stock and bond index funds by

around a third which will save investors

$47m annually and done away with mini-

mum investments across the board. And it

surely hopes it will be able to “upsell” cus-

tomers more lucrative products such as fi-

nancial advice.

That it was Fidelity that went to zero

first was something of a surprise. Its repu-

tation was made on the prowess of its

stockpickers. The move therefore reveals

just how much active management in

shares is suffering. Over the past decade

an average of 87% of actively managed

American equity funds underperformed

their benchmark indices. Average active-

management fees in 2017 were 0.57%.

Active-only asset managers have tried

to respond to pressure from passive funds

by consolidating. Examples include merg-

ers between Janus an American fund

house and Henderson an Anglo-Austra-

lian firm; and in Britain between Aber-

deen Investments and Standard Life. But it

is hard to see a reversal of the shift toward

passive management which by some esti-

mates already approaches half of all as-

sets in managed American equity funds.

Fidelity’s move is likely to prompt further

consolidation among passive-fund provid-

ers too even though many are already

giants. After all to make a decent income

from such activities as lending shares to

short-sellers means doing it at scale.

In recent years Fidelity has lost business

to rivals who had moved earlier to focus on

passive investing and to squeeze costs. It

was already shiftingits emphasis. In June a

net $5.6bn flowed into its passive fund of-

ferings even as it $2.6bn net flowed out of

its active strategies. Its new zero-cost funds

will surely accelerate this trend.

The price war in asset management

was already fierce. Will anyone go to the

wall? At the very least it is hard to imagine

that Fidelity’s rivals can hold off from low-

ering or even scrapping their fees too. As

free current accounts show once some-

thing is provided for nothing it is very diffi-

cult ever to start charging again. 7

Index investing

How low can

you go?

A milestone is reached with the first

zero-cost tracker funds

The EconomistAugust 4th 2018 Finance and economics 59

1

Myanmar’s state-owned enterprises

Living fossils

THAGAYA

The bureaucratic leviathans show how much economic reform is still needed

N

OTHING has been made in the engine

factory in Thagaya in the south of

Myanmar since April last year. Yet around

350 employees still turn up each day. In

2016 government-owned factories like this

one made a loss of more than $200m.

When Myanmar moved from military

dictatorship to a form of democracy its

new government embarked on a series of

reforms. Since 2011 it has passed at least

two dozen laws related to the economy.

Foreign investment much of it from China

has helped the economy to grow at around

7% a year. But it remains one of the region’s

poorest countries. And vast swathes of the

economy remain untouched.

State-owned enterprises (SOEs) employ

about 145000 people and provide about

half of government revenue excluding for-

eign aid. They collect around 12% ofGDP in

fiscal revenue and spend about the same.

But the junta-era law that regulates them is

a vaguely worded two-page document

that is silent on what they are supposed to

do. It simply states which sectors are gov-

ernment monopolies and promises prison

to anyone who encroaches.

Myanmar now has 31SOEs. Some are

decrepit industrial complexes like that in

Thagaya but others deal with juicy sectors

such as airlines gems oil and gas telecom-

munications and timber. Their economic

impact is huge. They not only pursue com-

mercial activities; most also collect taxes

and regulate the sectors they operate in.

A recent report by two think-tanks the

local Renaissance Institute and the Nation-

al Resources Government Institute in New

York details their freedom from govern-

ment oversight. The SOEs have no specific

performance targets or formal appoint-

ment procedures for senior staff—most are

run by former army men. Their accounts

are kept by hand in physical books. Audits

consist of nothing more than checking

bank statements against the figures they

provide. Only their total budgets are re-

ported to members of parliament who do

not get to see detailed line items.

Exceedingly conservative accounting

rules require them to set aside 55% of their

profits. Myanmar Gem Enterprise for in-

stance holds enough cash to run itself for

172 years earning no interest in a state-

owned bank. In January 2017 SOEs held