VictorReklaitis

Markets writer

Passive investing is now the mainstream approach, if you look at where dollars have flowed in the last 12 months.

But could the pendulum soon swing back to active managers — those stock pickers running higher-fee funds that try to beat the market?

Not so fast. Passive — the use of index-tracking mutual funds and ETFs — still has a long runway, says Chris Philips, a senior analyst at passive pioneer and $3 trillion juggernaut Vanguard. He also says there are skilled active managers.

This Q&A with Philips, who is part of Vanguard’s investment strategy group, has been lightly edited.

MarketWatch: It’s been said that passive investing is now the mainstream approach. Could the pendulum swing back to active funds run by stock pickers, because there’s an opportunity for them?

Philips: Passive is definitely taking on the vast majority if not all of the cash flows in the last couple of years. Investors are fleeing the traditional type of active management, at least on the equities side. But when all is said is done, passively managed products are still a significant minority of all the investable assets out there. So there’s still tremendous runway for passive strategies.

And when you look at other ways to use passive — if you think in terms of a small-cap European biotech ETF, technically that’s passive, but [investors] would probably be using that in a very active way. They might believe that small-cap European biotech stocks are set to take off, and that’s the exposure they want to get. So you can still have a very active portfolio by using passive products. The uptake of truly broad market, market-mimicking index funds and ETFs is a segment of passive, but it’s not the only passive that’s out there.

Could we see cash flows go back to true active funds? Absolutely, and most likely that would be driven by a series of months, quarters or years where the average active manager shows some level of outperformance. That’s probably the most likely catalyst for it. But I think we’re still in the early stages of the movement toward passive, and there’s still a long runway to go.

MarketWatch: When will there no longer be a runway for passive investing? Maybe in 30 years?

Philips: That’s pure speculation. There’s no way to actually determine whether there’s a “tipping point” where passive actually is too big. Because again, there can be a lot active components even within a passive portfolio — just from investors making sector bets or country bets relative to the global marketplace.

But I think it is conceivable that passive continues to grow. I don’t know what the year-over-year growth rate might look like. It could slow down. It could accelerate. I think the longer that traditional active continues to struggle in terms of performance and high fees, I think the more likely we are to see passive continue to gain market share.

If the hurdle in terms of costs starts to come down for active management, and performance starts to look a little bit better, you could start to see cash flows moderate in traditional passive and maybe go the other way. What we do advocate is that costs matter, and that’s the first and foremost thing that investors should look at.