The landscape of public fund-of-funds (FOF) products is undergoing a significant transformation, moving away from reliance on fund managers and their individual tacticsThis shift reflects a broader trend toward passive investment strategies, driven largely by the increasing efficiency of stock marketsAs of last weekend, we witnessed the culmination of annual performance reports, highlighting how index funds have stepped in to become the primary source of income for public FOFs, overtaking traditional active equity funds managed by prominent fund managers.

The public FOF products have yielded impressive annual performances, with top results exceeding 17%. Industry leaders such as Shenwan Hongyuan's Retirement Target FOF, Penghua Yicheng Active FOF, and China Europe Selection Mixed FOF dominated the rankings, reporting annual returns of 17.14%, 16.60%, and 13.34%, respectivelyOther noteworthy performers included Southern Retirement FOF, Guofu Retirement FOF, and Jianxin Excellent Progressive FOF, each surpassing a 12% return and solidifying their positions among the best-performing public FOFs.

The shift from active management to passive investment within FOFs could be seen as not merely a trend but a pivotal strategy indicating the future operational ethos of the sector

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It becomes clear that many of the leading public FOF products now heavily utilize index fund products for their performance rather than relying on the reputations of high-profile fund managersFor instance, the Shenwan Hongyuan Retirement Target FOF's regular reports reveal that nine out of its ten major holdings are passive ETFs, heavily focused on major public fund offerings such as the CSI 2000 ETF and the CSI 1000 ETF.

This movement towards passive strategies signals a broader recognition within the industry of the inherent issues related to the transparency and stability of actively managed fundsHistorically revered fund managers have increasingly struggled to deliver consistent and reliable returns, further reinforcing the FOFs' strategic shift toward index funds.

A critical example is found in Huabei Jinshan’s previously prominent China Europe Retirement FOFThis fund once boasted up to nine active equity funds among its top holdings, mostly steered by leading managers well-known for their track records

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However, in a surprising pivot, the fund now mirrors that of its competitors with its ten primary holdings composed solely of passive investments.

Analysts in the industry assert that as market efficiency continues to escalate, the challenge of achieving excess returns through active management is becoming increasingly evidentConsequently, public FOF strategies are expected to diminish the human factor that fund managers introduce to the investment process.

Moreover, there are growing concerns regarding the instability of active fund management strategiesThe fluctuations in performance can be stark and unpredictableFor example, a notable fund manager based in South China, who skyrocketed to fame in 2021 with returns that effectively doubled investors’ capital, has faced exponential decline across three subsequent years, resulting in cumulative losses exceeding 40%. Similarly, another fund manager, celebrated for achieving a 160% return in 2020, has witnessed significant losses in the following years, reflecting a growing pattern of unreliability among active management strategies.

The erratic behavior of actively managed funds has evidenced tension between the fund’s stated investment style and actual performance

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Moreover, the challenge of style drift—wherein funds shift unexpectedly from one investment style to another—has become more pronounced, undermining FOFs' positioning strategies.

For instance, if a fund manager strategically allocates positions within a conservative bid-bond hybrid fund, it may reflect a conservation approach that aligns with the overall portfolioHowever, an unforeseen shift in the fund's style to a more aggressive equity strategy can derail that original strategy entirely, leaving FOFs scrambling to realign their investments with previously established guidelines.

Notably, recent announcements by various bond-oriented hybrid funds indicated shifts in management that could lead to significant changes in investment strategyMany of these managers possess backgrounds that lean toward higher-risk equity investments, translating to potential upheaval in previously conservative portfolio holdings.

This volatility also became apparent in a highly rated active equity fund, such as Debang Xinxing Value Fund, which saw a complete overhaul in its top holdings within just the course of a year

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Initially concentrated in pharmaceuticals, its leading stocks transitioned entirely to technology-oriented companies, revealing the unpredictable nature of these funds.

Given the fluctuating performance of actively managed funds, public FOFs have increasingly gravitated toward more predictable, transparent options such as index funds, which inherently carry less risk of abrupt strategic shiftsIndex funds present a more compliant investment approach, minimizing the likelihood of sharp performance changes through human intervention.

Additionally, the implications of lower research costs when choosing index funds cannot be overstatedThe traditional model of FOF research heavily emphasizes frequent interactions and assessments of active fund managersThis process often incurs significant costs and proves to be less effective as discrepancies between expected and realized fund performance become apparent.

A FOF investment supervisor in Shenzhen described the intense research regime, often involving dozens of meetings with fund managers to ascertain individual fund strategies and preferences

However, the necessity for such extensive research diminishes significantly when shifting to index funds, which naturally possess more transparent and predictable performance metrics.

The trend toward indexification within public FOFs not only aids in achieving a stable performance profile but also addresses the growing demand from investors for lower costs and higher efficiency—features inherent to passive investment strategiesIncreasingly, investors are seeking ways to transition from actively managed portfolios toward more capital-efficient, long-term strategies encompassing diversified holdings.

A report recently highlighted that, following a bullish momentum in U.Stech stocks, the difficulty for active funds to outperform market indices has considerably increasedOver 70% of active funds showed an allocation to technology lower than the S&P 500 ETF, failing to outperform the index significantly