IAF: Can Accomplish Similar With Passive EWA

Australian investors have been quietly abandoning active fund managers in record numbers. A staggering 85.4% of Australian equity funds underperformed the S&P/ASX 200 index over 15 years according to the 2023 SPIVA report. This isn't just an Australia-specific phenomenon - global active managers barely outperformed passive benchmarks, with only 24% managing to beat the market over a decade according to Morningstar's analysis. The pattern reveals a fundamental shift in investor confidence as repeated underperformance exposes the limitations of traditional stock-picking approaches. While 2023 saw some temporary respite for active strategies, including a 19% success rate for bond managers, equity managers continued to struggle against well-researched passive indexes that simply track market leaders. The 2024 data confirms this isn't a temporary setback but an ongoing structural challenge, with global active managers underperforming the MSCI ACWI benchmark by an average of 3.1 percentage points. This performance gap has created what we call "substitution demand" - investors systematically shifting capital from underperforming active funds to passive vehicles like the iShares MSCI Australia ETF (EWA). The evidence suggests this isn't just about short-term results, but reflects deeper market dynamics where concentrated ownership of a few "Mag-7" stocks has outperformed the broad market, putting additional pressure on traditional active management approaches that haven't adapted quickly enough. While some quantitative managers with sophisticated risk controls have bucked this trend, the overall trajectory points toward continued pressure on active funds as investors increasingly recognize the persistent outperformance of passive strategies.

The market's shifting structure is creating a new advantage for passive investors. Concentration at the top of major indices means a handful of mega-cap stocks now drive global returns, fundamentally altering the performance landscape. This structural change, combined with dramatically lower costs, is powering passive strategies to outpace their active peers.

In 2024, this dynamic played out clearly. Global active managers lagged the broad MSCI ACWI benchmark by a median of over 3.1 percentage points, a shortfall largely attributed to the outsized influence of just a few dominant companies, often called the "Mag-7" (or their regional equivalents). Australian managers saw similar struggles, slightly trailing the S&P/ASX 300 overall. Growth-focused active managers fared slightly better locally, but value managers continued to lag, highlighting the challenge active funds face in this narrow market environment.

Passive funds tracking the MSCI Australia Index, like the iShares MSCI Australia ETF (EWA), are uniquely positioned to capture gains from this concentrated leadership. EWA's portfolio reflects this reality, with its top five holdings – led by Commonwealth Bank of Australia, BHP Group, and Westpac Banking – comprising roughly 36.18% of the fund. By design, passive funds like EWA simply hold these dominant stocks in the exact proportions dictated by their market capitalization within the index, avoiding the costly guesswork active managers engage in.

This concentration advantage is amplified by EWA's significantly lower expense ratio. Compared to typical active funds, which often charge 1.0% or more in annual fees, EWA's cost structure is roughly 70% cheaper. Those savings aren't just pocketed by the fund manager; they compound over time, directly boosting net investor returns. In an environment where active managers are fighting an uphill battle against index performance, these efficiency savings become a powerful, self-reinforcing benefit.

Some might argue high concentration increases risk or tracking error – the difference between a fund's return and its benchmark. While true concentration exists, EWA's tracking error remains within acceptable thresholds for a passive strategy. Its holdings mirror the index composition closely, ensuring the fund reliably captures the returns of the concentrated Australian mega-caps. The persistent outperformance of passive strategies like EWA, driven by this combination of unavoidable exposure to market leaders and drastically reduced costs, signals a lasting shift favoring index-based investing.

The quiet shift toward passive investing isn't just a trend-it's accelerating, driven by undeniable performance and institutional confidence. Global active managers struggled mightily in 2024, underperforming the MSCI ACWI benchmark by a significant margin, with a median shortfall exceeding 3.1%. This pressure was mirrored locally in Australia, where active funds slightly trailed the S&P/ASX 300 index. Meanwhile, passive strategies like EWA captured the upside from concentrated market leadership. Crucially, Australian institutional investors are responding: passive allocations within major institutional portfolios are climbing at an annual clip exceeding 5%, a clear signal of growing penetration. This performance-driven migration isn't just about past results; it's creating powerful momentum. The substitution demand is real, with passive funds systematically outpacing active managers across asset classes in recent years. Looking ahead, this momentum sets the stage for a significant catalyst: expected robust institutional flows into the EWA ETF in Q1 2025, as the sector's proven track record and rising adoption converge to fuel further growth.

The numbers tell a story Australian investors can no longer ignore: active fund managers are systematically failing to beat the market. In 2023, 77% of Australian equity funds underperformed the S&P/ASX 200 benchmark, with the gap widening to 85.4% over 15 years. This isn't a blip-it's a persistent pattern. Just 6.25% of top-quartile active funds maintained their status year-over-year, suggesting skill-based outperformance is rarer than seasonal snow in Sydney. Global data shows similar trends: while 47% of U.S. active funds outperformed in short-term windows, only 24% did so over a decade.

The evidence points to a structural shift. Investors are abandoning costly active strategies for low-cost index exposure, with the iShares MSCI Australia ETF (EWA) representing the new standard. EWA's portfolio of 56 stocks reflects the market's largest companies, offering investors a transparent, cost-efficient alternative. The writing is on the wall: passive investing isn't just surviving-it's thriving. The question now becomes whether the industry can adapt fast enough. This section will dissect the growth implications for passive vehicles, using penetration rates, substitution demand, and performance persistence as our compass.