Passively Managed Funds Gaining in Popularity

October 26, 2012 | Greg Leonberger, FSA, EA, MAAA, FCA, Director of Research, Managing Partner

Our Chart of the Week examines the migration of dollars from active to passive U.S. equity mutual funds over the last five years. During this time period, approximately $144 billion of investor money has flowed into passive funds (blue line) on a net basis, thus reflecting a growing frustration with the performance (and perhaps as importantly, fee level) of actively managed funds. Even more telling is the movement out of actively managed funds, as shown by the red line on the chart. From 1st quarter of 2007 through the 3rd quarter of 2012, over $460 billion has been moved out of actively managed funds and into other investment vehicles.

Why the dramatic movement, most especially out of actively managed funds? A few explanations come to mind. First, it is no secret that the equity markets have largely traded on macroeconomic factors the last four years, so it has been hard for fundamentally-based managers to consistently add value when the market has not traded on those very optics used to evaluate equities. In addition, the bond bull market has attracted capital as investors have moved to ride rates down, as well as preserve the principal value of their investments. Last, as investors become more cost conscious, the low fees of passively managed funds have helped to attract additional capital.

The cloudy economic outlook suggests that this trend may continue. Whether it is a short term uncertainty such as the fiscal cliff or a longer-term matter about the future of a regional currency (Europe), it is conceivable that the market will remain a risk on / risk off trade over the next few years. Therefore, we may see continued flows into passively managed funds in the equity markets.