Defenders of active management have said that rough patches in the market should demonstrate the value of active funds as well as the fallibility of their passive peers. But data from last year doesn’t seem to be bearing that out.
According to a newly released research report from Moody’s, the adoption of passive investment products in the US is continuing unabated. In spite of market volatility that “theoretically should have created more opportunities for active managers to generate trading gains,” the share of investment flows going to active funds did not increase, and passive flows did not weaken.
Last year, mutual funds saw their highest annual recorded outflow within the Investment Company Institute (ICI) dataset. Active funds, Moody’s noted, tend to exhibit greater “leakage in earnings” through management fees paid to asset managers, commissions and trading costs to brokers, and below-average investment decisions that cause average active managers to lose money to the smaller group of truly superior ones.
The shift to passive ETF products has led to a pickup in mergers and acquisitions as US managers seek passive ETF assets to assimilate, the report observed. It also pointed to a continuing fee war in the passive space, kicked off by Fidelity’s launch of zero-fee index funds last year and escalated by other managers who are following suit.
“Whether these products in and of themselves gain significant AUM, the more meaningful impact is to the psychology of the marketplace where credible product offerings at lower price points are established,” Moody’s said.
The endurance of passive inflows was also observed in data from fund tracker Morningstar Direct. According to the Wall Street Journal, net inflows into ETFs, the most popular passive vehicle, totalled US$203 billion between September and January, while passive mutual funds soaked up US$167 billion.
“Meanwhile, almost $370 billion flowed out of active mutual funds,” the Journal said.
The persistence in inflows, even during the market rout, could be due in part to many portfolio managers switching to ETFs; more liquid than individual stocks and bonds, they were seen as an ideal way to escape the turbulence. Bankers, fund managers, and institutional investors responding to surveys have pointed to this pattern.
As for the persistent outflows from active funds, it’s possible that investors who trust managers to time the market are less forgiving, making them more likely to demand their cash back when things get rough.
The inflows into ETFs seem to run against the theory that they can worsen panic-driven selloffs. Active managers would point out that since ETFs are often more liquid than their underlying assets, ETF investors can sell off their shares more easily than the ETF can sell its holdings; the result would be assets offered at a discount, which exacerbates the selloff.
“The theory has a kernel of truth: ETFs that track assets that are complex, very illiquid or hard to value should be handled carefully,” the Journal said. “Yet there is little evidence of ETFs misfiring when they track simple assets such as stocks and bonds.”
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