Passive investments in the US will overtake the active market share no later than 2024, according to a recent report by Moody’s Investors Services.
Moody’s has analysed the trends in the passives market, which has seen inflows of $505bn in the US last year, while outflows from actively managed funds totaled $340bn, and has forecast the point at which passives will surpass active funds’ market share.
Given its current rate of growth and the trends in the active market, Moody’s is estimating passives will exceed 50% of the overall market share in the US between 2021 and 2024.
The firm said it arrived at this conclusion by using two approaches: a simple regression analysis of market share versus time; and by fitting recent AUM data for passive funds to a diffusion model that projects near-time market share growth.
US active mutual fund industry in net outflows since 2007
Moody’s points to the fact that the US active mutual fund industry has been in net outflows since 2007, driven by “investors’ growing awareness that, by definition, actively managed investments, in aggregate, cannot deliver above average performance, and that investing is therefore a zero-sum game – for every winner, there must be a loser(s)”.
Criticisms of the active management industry
Similar criticisms of the active management industry emerging in the UK, where the Financial Conduct Authority (FCA) last year released a paper criticising active managers for charging high fees for investments that did not deliver significant outperformance to justify the charges. The report, Asset Management Market Study, said there are some £109bn of assets sitting in these underperforming active funds.
Global growth in passives, beta investments and robo-advisory
Meanwhile, Moody’s sees “plenty of room for global growth” in passives, with penetration in the highly developed US financial market still standing at just 28.5%, and much lower in the rest of the world at approximately 5%-15%.
Until now, growth in passives has been seen primarily in the most liquid equity markets, but Moody’s believes a larger range of asset classes will benefit as ETF and indexing technology continues to advance.
Moody’s said investors will continue to shift into passives over the next five to ten years, allocating to “beta” investments of all types – simple, smart, and exotic. “We expect the next battleground for investor dollars to be in smart beta and multifactor funds, which will undercut traditional active products and offer similar potential expected return profiles,” the report said.
The agency also foresees strong growth in the robo-advice space, which currently makes up only a small part of the market, as it becomes a key distribution channel for low-cost investment options, spurred by the fact the business model has especially strong support from the younger generation.
Meanwhile, Moody’s predicts passives could grow overseas at a similar rate to the US, “as long as corporate governance improves to developed-market standards”.