18 min read 14 Jun 19
The investment industry has gone through a myriad of changes since the turn of the 20th century, fuelled by innovation, technology, regulatory changes and evolving investor preferences. Over the past five decades, we’ve witnessed a sizeable uptick in the pace of this change, which has broadened the opportunity set for investors and changed the way they can access these opportunities. By tracing the key developments since the beginning of last century, we can reflect on the factors that have been most influential in the evolution of the industry to date.
Technology and innovation have been the constants throughout history that have underpinned a global wave of transformation. From the Industrial Revolution through to the Golden Age of Invention in the late 19th century, to the Tech boom and information ‘overload’ permeating society today. These transformations have given rise to entirely new industries and the changes can be seen in the shifting composition of listed companies on global stock markets.
In 1900 equity markets were dominated by the rail industry. More than a century later we’ve seen the rise in dominance of industries such as healthcare, energy, and technology.
At the turn of the 20th century no one had sent an e-mail or a text, let alone a tweet. In the world of ‘high-tech’ we can compare telegraphy then with the smartphones of today. Within manufacturing and industrials the dominant listed companies in 1900 were the world’s then-largest candle maker and the biggest manufacturer of matches.
While the investment landscape continued to evolve to reflect the growth opportunities of the time, by the mid-20th century equity market participation remained low. The Wall Street market crash of 1929 and the Great Depression that followed remained firmly planted in investors’ minds while market access could be slow and costly. Limited competition among independent US stock brokers allowed them to charge high fixed commissions while a lack of technology meant that it took considerable time to execute trades.
The ‘great mutual fund boom’ was still years away but change was afoot on the back of technological advancements and progressive regulatory reforms. In 1954 the New York Stock Exchange (NYSE) announced a ‘monthly investment plan program’ allowing investments of as little as $40 /month. This was the precursor to the monthly investment plans marketed by mutual funds which would lead to the wide-spread adoption of stock investing the 1970s and 80s. Trades were increasingly being settled electronically rather than in physical form and the Securities & Exchange Commission (SEC) would go on to ban minimum fixed commission rates.
Improvements in trade processing and settlement through the increased use of automation and technology laid the foundations for higher trading volumes and the increasing popularity of stock investing in the years ahead. In 1974 trading hours on the NYSE were extended by 30 minutes to accommodate the market growth. By the 1980s US daily trading volumes had grown from less than 1 million shares in 1952 to 100 million shares in 1982.
As interest and participation in stock markets grew, many investors were looking for opportunities beyond the developed markets and started to see the potential in emerging markets.
In 1986 the first closed-ended global emerging markets equity fund was launched. A year later the MSCI developed its first emerging markets indices. The MSCI Emerging Markets (EM) index consisted of just 10 countries at launch and represented less than 1% of global market capitalisation. As capital controls were gradually relaxed across the emerging markets and investors’ access grew, the number of country level constituents began to rise. Today 24 countries are included in the MSCI EM index representing around 11% of global market capitalisation.
The growth of emerging market economies has coincided with the rise of globalisation. The free flow of trade, capital, people, technology and ideas across national borders and regions has powered growth in these markets.
While the challenges of corporate governance and market liquidity remain today, the corporate environment has improved and the market has evolved. Joint projects with the World Bank’s International Finance Corporation, global businesses and local representatives in emerging economies have helped to improve corporate transparency and create new standards on disclosure.
EM companies, in aggregate, may still lag their developed market counterparts, particularly in the areas of disclosure and shareholder engagement, but there is a growing awareness and understanding of best practice. In South Korea, for example, international investors and South Korean policymakers have been putting pressure on family-owned conglomerates, known as chaebols, to adopt more shareholder-friendly measures, change their structures and improve their business practices. This is starting to deliver results. Dividend payments have risen significantly although they remain low. In addition, investigations of scandals in recent years have given rise to a slew of proposed bills related to corporate governance; encouraging fundamental corporate restructuring and improved minority shareholders’ rights.
EM management teams are recognising that governance is being viewed as an indicator of the firm’s long-term prospects and that poor governance can impact their access to capital. This also applies across company supply chains with an increasing awareness of the reputational damage that can follow weak standards and controls.
From the green shoots of growth, many initially ‘commodity-driven’ emerging economies have grown rapidly, with companies becoming increasingly innovative and adopting new technologies to ‘leap frog’ traditional operating models in a variety of industries.
Chinese ‘tech’ giants such as Alibaba and Baidu have grown exponentially to rival US trailblazers including Amazon and Google. Tech companies constituted around 3% of the emerging markets universe in the late 1990s, today 25% of the MSCI EM Index is in tech-related stocks.
By the end of the 1990s the emerging economies’ contribution to global GDP had outstripped that of the major (G7) advanced economies, with China’s contribution following a similar trajectory. The country’s R&D spend is only second to the US and it is expected to account for 33% of global GDP growth in 2019.
As the global opportunity set for investors has burgeoned, so too has the number of instruments through which to access these opportunities. Since the global financial crisis the rise of passive investing has been reshaping the investment landscape. In a low return world investors are increasingly looking for low cost, liquid vehicles to gain market exposure.
The global size of the passives market is now estimated to be US$17 trillion with equities holding the highest share of passive assets.
ETFs, which can be traded intraday, have been some of the greatest beneficiaries of the shift from active to passive funds over the past decade. Global ETF assets totalled just $410 billion in 2005 and grew to $5.3 trillion by March 2019. Arguably the roots of passive investing can be traced back hundreds of years but the idea of the modern index fund, as we know it today, began to take hold in the mid-20th century.
The fundamental premise for the creation of index funds stems from the famed economist Eugene Fama’s efficient-market hypothesis which asserts that asset prices rapidly incorporate all known information implying that excess future returns are not predictable. The theory has been challenged and hotly debated by both academics and industry peers. For example, some point to the psychological and behavioural aspects of investing and the influence of these factors on asset price determination. Nevertheless, by the early 1970s his ideas had given rise to a handful of index funds geared towards institutional investors.
However, it wasn’t until index fund pioneer John ’Jack’ Bogle embarked on what was to become a life-time crusade that passive investing really began to take hold. Bogle is most readily credited with ‘democratising’ investment by bringing passive investing to the masses. Employing some of the ideas he had originally touted in his 1951 Princeton thesis “The Economic Role of the Investment Company”, he launched the ‘First Index Investment Trust’ in 1976 to track the S&P500 Index.
His ideas set him up as a contrarian amongst most industry peers at the time and the launch attracted derisive comments with some referring to the fund as ‘Bogle’s Folly’. However, despite a challenging start there’s no denying the subsequent commercial success of the fund – known today as the Vanguard 500 Index Fund which grew assets from US$11 million in 1976 to over US$400 billion today.
The rapid growth of passively-managed assets has generated debate about their possible impact on markets, especially their potential to distort security prices. For now, despite the rising interest in passive funds, their holdings as a share of total outstanding securities remains at a relatively low level due to the sizeable holdings of other investors in the market.
The share of securities held by passive funds is highest for the US equity market but only accounts for around 15% of the total. Shares of passive funds in other markets are lower – at about 5% or less.
In practice, the distinction between passive and active strategies is becoming increasingly blurred given the rise of ‘smart beta’ funds. These funds typically implement factor-weighted strategies (e.g. value, low volatility, yield) rather than tracking traditional market cap-weighted indices. As such, their construction can be considered active in nature.
Nevertheless, there has been an observable trend towards passive investing. Over the past decade ultra-loose monetary policy globally has provided a tailwind for passive instruments and ‘cheap beta’ has been readily available.
A number of structural shifts in the industry have also supported this trend, including the rise of ‘robo-advisers’ (platforms offering low-fee automated investment management services), the introduction of fiduciary duty requirements, and a greater focus by regulators on fee transparency.
Changing investor behaviour has also given rise to a proliferation of Environmental, Social and Governance or ‘ESG’ focused funds. Investors are motivated to invest responsibly for different reasons – from value alignment to risk management, to changing regulatory frameworks and governing body standards.
Environmental, Social and Governance factors are fundamentally different and, for investors, the importance of each may vary according to their specific values, goals and priorities. Investment managers (acting on behalf of security holders) have traditionally been more concerned with corporate governance – which is typically considered a strong indicator of management quality.
However, investors’ growing concerns around issues such as carbon emissions, climate change, health and welfare, and corporate conduct are prompting investment decision-makers to increasingly incorporate a broader set of the factors when considering the attractiveness of any given investment opportunity. This has led to an ever-expanding collection of both passive and active funds offering some level of ESG engagement, integration and measurement.
The adoption of ESG factors into mainstream investing has evolved from its early stages. It began with negative screening – which excludes specific companies or industries that are in conflict with investors’ preferences or social norms. The step up from here is positive ‘best-in-class’ screening – actively selecting companies with desirable characteristics; those that screen comparatively well based on specific ESG criteria. More recently, investment managers have begun to incorporate ESG considerations into all aspects of the investment process, an approach commonly referred to as ESG integration. This has also led to greater corporate engagement, with investors increasingly raising ESG shortcomings with investee companies in an effort to encourage better practices.
The way investment managers measure and incorporate these factors into their investment process, and the means by which investments represent ESG goals, can vary widely.
In many ways, the growing number of ESG-related investment options and instruments has moved ahead of a cohesive way of comparing different approaches and measuring outcomes. This, combined with opacity around terminology, is creating a number of challenges for investors.
So although the interest in ‘responsible’ or ‘sustainable’ investing has grown exponentially over the past few years, and ESG-related company and benchmark data is much more readily available, there is still room for improvement in measuring and comparing various ESG-orientated investment approaches.
At the turn of the 20th century, few could have predicted the rapid developments in global markets that we have witnessed since. The fundamental shifts over the past 100 years or so speak to the influence of innovation, technology, society and politics in reshaping the global investment landscape. In the more recent past, technological advances have been the driving force behind the exponential pace of change.
In many ways, advances in communications and technology have made the world a smaller place. In a world of globalisation, geographic distance is no longer a hurdle to integration. Consumers can benefit from a global marketplace, investors have access to an ever-broader global universe, and company production lines are extending across geographic boundaries as businesses develop a complex network of Global Value Chains to meet the demands of a worldwide customer base.
However, in our current technology-enabled environment, we have replaced physical barriers with ‘walls of information’. Technology may have made market access easier, but decision-making amid the information overload has become increasingly challenging. Sifting through the ‘noise’ has become the new norm. The proliferation of product choice and market participants has added to the complexity.
Given the magnitude and pace of change that we’ve seen, it’s difficult to extrapolate from the norms of the past and apply them to the ‘new norms’ of the future and, without a crystal ball, the road ahead remains unpaved.
At the turn of the 21st century, new influences (if not yet mainstream) have started to emerge. Automation, robotics, artificial intelligence, cryptocurrencies, clean energy, big data, cyber security and information warfare – all themes for the new millennium. Where will we be in 50-to-100 years from now? Some say forecasting is a mug’s game, but one thing is for certain – change is constant.
 Source: Investopedia, ‘Stocks then and now: The 1950s and the 1970s’
 Source: MSCI, The MSCI Emerging Markets and MSCI All Country World Indices were launched on 31 December 1987
 Source: Erste AM, https://blog.en.erste-am.com/changes-msci-emerging-markets-index/
 Source: Mark Mobius, Emerging Markets Through the Years, Jan 2018 http://emergingmarkets.blog.franklintempleton.com/wp-content/uploads/pdfs/10864.pdf
 Source: MSCI, MSCI EM Index as at 31 May 2019, Note: total weight includes IT sector + Alibaba, Tencent, Baidu and Naspers
 Source: www.visualcapitalist.com, IMF, Standard Chartered, Mar 2019
 Source: Casey Quirk, as at Mar 2019 https://www.ft.com/content/5c6bf51a-4660-11e9-a965-23d669740bfb
 Source: BIS, Apr 2011 ‘Market structures and systematic risks of ETFs’
 Source: https://etfgi.com/news/press-releases/2019/03/etfgi-reports-assets-invested-global-etf-and-etp-industry-reached
 Source: http://johncbogle.com/wordpress/wp-content/uploads/2011/09/The-Professor-The-Student-and-the-Index-Fund-9-4-11.pdf
 Source: https://www.ft.com/content/91054b00-19dd-11e9-9e64-d150b3105d21
 Source: BIS Quarterly Review, March 2018, ‘The implications of passive investing for securities markets’. Note: excludes non-fund investments
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