The great passive road trip; when will it end?
The near decade long rise of passive management in Australia, largely at the expense of active managers, has been well documented.
The question we’ve been asking as we compile the Tria Managed Funds Review each quarter is how far will this trend run?
The chart below illustrates the last 3 years (and one quarter) of this trend.
As you can see net inflows to passive domestic and international equity have slowed recently (note: 2015’s big net international outflow includes one very large institutional redemption).
Is passive now at or close to its peak?
Past flows aren’t necessarily good predictors of the future but if we cast our eyes to comparable offshore markets and exposures to active and passive equity funds there, we might get a better idea of what the future holds. For comparison purposes we’ve selected US mutual funds where passive managers have been taking stronger flows for longer than in Australia.
Source: Tria Managed Funds Review, Investment Company Institute, Morningstar, Tria analysis
Today US managed fund investors are around twice as likely to invest passively in domestic equities as Australian investors. Recent flows to US mutual funds, illustrated below, provide evidence that the market share of passive continues to increase.
These figures are pretty alarming – the huge rotation to passive strategies underway in the US is incredibly value destructive for active managers. Can we expect the same experience here?
While there are clear differences between the US and Australian asset management markets, the underlying factors driving the move to passive are largely common to both markets (as are the passive managers who are positioning themselves to benefit by making the case for passive and against active), including:
- the perception that active managers have disappointed while charging high fees; and
- pressure for portfolio constructors to drive down costs.
Meanwhile, active managers have failed to mount a concise and consistent public defence of the active management proposition. The debate isn’t being lost – it’s not even being fought. There is much work for active managers to do to make their case heard.
If assets continue to flow into passive funds at the expense of active, the implication for Australia’s asset management market is obvious: lower profit margins as the assets flow to lower cost (and lower margin) products.
There are ways for active managers to stay relevant and defend market share (in addition to delivering sustained outperformance and publicly defending their proposition) including:
- improving their service offer to investors and intermediaries (eg providing value-adding digital services);
- targeting growing asset pools such as managed accounts; and
- new product development to deliver premium, higher-margin offers.
Pressure on fees is so intense that the rotation to passive can be expected to continue. Even if it doesn’t get as extreme as it is in the US it’s still concerning for active managers. Managers should view the US experience as a warning sign – the time to act is now. Be clear on your value proposition, think about delivering value separate to the investment returns you generate, and make a clear, public case for active management. While you have the chance. Because passive managers are overwhelmingly winning the argument… and flows are following.
Never miss a Trialogue! Sign up to receive future Trialogues direct to your inbox.