Passive US funds poised to overtake active, ISS says

Index funds will control more than half of long-term invested US assets by the end of 2027, according to ISS Market Intelligence.

Active fund’s share of the US market will fall from 53 per cent in 2022 to 44 per cent in five years, the research group, part of the Institutional Shareholder Services group, estimates. Most of the market share will go to index exchange traded funds, which are expected to garner $2tn in new sales. Active mutual funds, meanwhile, will bear the brunt of outflows, according to the report, with an estimated $1.4tn in net redemptions expected over the next five years.

Investors have pulled an average of $258bn from active mutual funds each year since 2015, according to Morningstar Direct. During the same period, passive mutual funds added an average of $138bn each year, the database shows.

Last year, active mutual funds in the US posted $1tn in net outflows, the database shows, the largest amount ever. The second-highest net redemptions from the products occurred in 2018, when investors pulled $336.5bn from the funds. Passive mutual funds, meanwhile, collected $53.8bn in net inflows in 2022. Active mutual funds had $11.6tn in assets as of December 31, and index mutual funds had $4.7tn.

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In contrast, investors poured $505.8bn into US passive ETFs last year and $87.8bn into active ETFs, according to Morningstar’s database. Active ETFs in the US had $343.7bn in assets and passive ETFs had $6.2bn as of the end of December.

Investors are beginning to embrace model portfolios, said Christopher Davis, head of US fund research at ISS Market Intelligence, and index funds, especially ETFs, are especially suitable for this approach to building a managed collection of assets.

In addition, the market is becoming even more favourable for index funds because of the rise of commission-free trading, Davis said.

“Another potential catalyst [for the pivot towards index funds] is the difficult market environment that we had last year. A lot of times, what ends up happening in a bull market is investors are wary to sell their existing holdings,” Davis said. It is a lot easier to unload legacy positions in mutual funds in a market downturn, he added.

Investors poured $56bn into the $1.2tn Vanguard Total Stock Market Index Fund, the top-selling index fund in 2022, the Morningstar data show. Meanwhile, the $744.8bn Vanguard 500 Index Fund, the second-best-selling index fund of the year, added $51.5bn.

ISS expects long-term fund assets under management will rebound from the slump in 2022 to historically normal growth rates over the next five years. The median five-year rolling asset growth rate from 2000 to 2027 is estimated to be about 7 per cent.

Mutual funds and ETFs will add $8.6tn in assets under management during the period, including through market appreciation, and will reach nearly $29.8tn by 2027, the researcher estimates.

Sales, meanwhile, are projected to total $2.7tn over the next five years, representing a 2.4 per cent annualised growth rate, the report says.

*Ignites is a news service published by FT Specialist for professionals working in the asset management industry. It covers everything from new product launches to regulations and industry trends. Trials and subscriptions are available at ignites.com.

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