Half of U.S. stock investors are now betting that they can’t beat the market.
Assets in passive domestic stock funds have grown to $4.3 trillion, the same amount held by active managers, as of the end of last month. According to Morningstar, parity between active and passive has been the inevitable result of twelve years of relentless outflows from active funds coupled with a steady flow into passive assets.
The milestone is the latest evidence of the upending of the asset management industry by the popularity of low-cost index funds. The rise of passive strategies is at the heart of the gloomy forecast for the future of asset management. While demographics, technology, and other factors are also to blame, active managers have been primarily struggling under the fee pressure unleashed by passive products. Index funds reaching the level of active portfolios is a sign that the industry has been permanently changed by the idea that animated the life of Jack Bogle, founder of the Vanguard Group, which invented the index mutual fund in 1976.
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“The question now is the degree to which active management will remain the preferred destination for investors in other asset classes, such as international equities and taxable-bond funds,” according to a Morningstar commentary analyzing U.S. fund flows.
It wasn’t so long ago that the idea of passively invested assets equaling those in active funds seemed unrealistic. At the end of 1998, the amount investors held in active U.S. stock funds was 6.5 times that in index funds. Two years later, with the launch of Barclays Global Investors’ iShares exchange-traded funds, passive started chipping away at the dominance of active managers. But even then, the amount held in active funds was still 5 times that of index funds.
In 2007, active assets in the U.S. stock category amounted to over $3 trillion, compared to less than $1 trillion invested in index funds. But after the financial crisis, as investors lost faith in the financial industry in general and in active managers’ ability to protect them from the market rout, investors’ tastes seemed to permanently change.
“The brutal bear market of the financial crisis appeared to change the landscape for good,” the Morningstar commentary stated. “Even though index funds had held the cost advantage, until then many investors still counted on stock-pickers to help them beat the market—and many active managers had marketed themselves as offering better performance in market declines.”
Ben Johnson, head of Morningstar’s passive strategy research, was quoted in the commentary saying that part of the active-passive dynamic is also due to the growing popularity of separately managed accounts and collective investment trusts at the expense of open-end mutual funds.
It’s not all bad news for active managers: Investors still prefer active strategies in areas of the market where information is less available and trading is more difficult. For one, 95 percent of municipal bonds are in active strategies. Investors also still prefer active managers in international stocks and taxable bond funds.