Will Investors Continue to Move Away from Active U.S. Equity Strategies?

February 03, 2017

This week’s chart shows asset flows between active and passively managed mutual funds and exchange traded funds (ETFs) in U.S. equities. Over the last eleven calendar years, active strategies experienced cumulative outflows totaling $864 billion, while passive strategies saw inflows of nearly $460 billion.

Strong passive flows such as this can potentially have a negative effect on active performance since stocks are less able to differentiate themselves on fundamental factors. When passive strategies receive significant inflows, all stocks in an index are purchased and receive price support. This can have a material impact on stocks with limited trading volume, thus this is more of an issue for small-cap versus mid or large-cap. Within small-cap, passive inflows in 2016 totaled $7.6 billion while active outflows totaled $18.5 billion. The Russell 2000 Value posted the strongest return within the nine U.S. equity style boxes during 2016, while active strategy outperformance in small-cap value was especially challenged relative to the other style boxes.

With passive U.S. equity indices ranking in the top half or better of their respective peer groups in recent years, active strategies have largely lagged behind their benchmarks. This performance lag is a primary reason why asset flows have shifted to passive strategies. Since a passive strategy essentially owns the market, passive allocations have fully participated in the current bull market, while active strategy performance depends on how a particular fund’s bets fared relative to its benchmark. Passive investing represents a low-cost means of gaining exposure to an asset class and fees are often a small fraction of the fees paid for active management. With valuations at or close to all-time highs, active manager performance will be closely monitored in 2017 to see if their higher fees are justified in this current market environment.