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Market Extra: An odd bit of good news for active managers: investors flee—but less rapidly

June 5, 2017
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There is good news for active managers. Or to be more precise, the bad news isn’t as bad: Investors are abandoning active strategies at a slower rate than before.

Actively managed funds, which as a category have seen sharp outflows for years as investors move instead to passive funds, have started to staunch the bleeding a bit alongside a recent improvement in aggregate performance.

According to Deutsche Bank, “the pace of passive share gains are slowing this year,” compared with late 2016, thanks to “modestly improving active performance” as well as “more optimism for a rebound in active alpha.”

Alpha refers to the degree to which an actively managed fund—where the components are selected by an individual or team—delivers a better return than its comparable benchmark index. Passive funds, in contrast, track an index like the S&P 500












SPX, -0.28%










 by holding what it does, and in the same proportions. Data have repeatedly shown that basically no active funds can consistently beat the market over long periods, particularly when fees are taken into account. However, there has been a higher rate of outperforming funds thus far in 2017, a fact that is almost completely attributable to whether or not the funds are holding technology stocks.

As a result of the improved performance, as well as a greater investor tilt toward riskier assets like stocks, “we reduced our active outflow assumptions for 2017 and also modestly reduced longer-term passive market share gain assumptions,” Deutsche Bank wrote.

Related:Will tech rally continue? Hedge funds say yes, but mutual funds say no

The German investment bank isn’t the first to find optimism in the deceleration of investors leaving the category. In February, Morgan Stanley called “improved outflows” for active funds “a turning point” for the industry.

See also: Wells Fargo joins the chorus of active management optimists

According to Morningstar, active funds saw outflows of $285.2 billion in 2016; passive funds attracted inflows of $428.7 billion. That trend has continued in 2017, albeit to a smaller degree, the shift that Deutsche Bank and Morgan Stanley see as tapering.

So far this year, per Morningstar data, active funds have seen outflows of $15.5 billion, a comparably small rate of redemptions compared with 2016; one month even had positive flows for active strategies, due largely to actively managed bond funds, a market sector where experts say active management can add value. (Morningstar’s data goes through April, the most recent complete month for which it has data.)

Passive continues to dominate on flows. In the first four months of the year, passive funds had inflows of $278.6 billion, and in February—the month where flows into active strategies were positive—the $8.15 billion move into active was dwarfed by the $74.3 billion that went into passive.

A reversal from this trend—for active funds to have positive flows while passive flows turn negative—seems exceedingly unlikely. In addition to their typically better performance, passive funds have been widely favored by investors because they charge lower fees. Passive adoption is also expected to accelerate because of the Labor Department’s “fiduciary rule,” which requires that the financial advisers and brokers who handle individual retirement and 401(k) accounts must act in the best interest of their clients. These guidelines are expected to favor passive strategies because of their lower fees and because they, by definition, can’t underperform.

However, most experts say the rules won’t prohibit advisers from recommending active products, or leave them vulnerable in the event they recommend an active fund that ends up underperforming. Deutsche Bank cited “less anxiety about litigation risk” pertaining to the fiduciary rule as another reason the retreat from active was slowing.

Despite that, Deutsche Bank expects passive equity strategies will overtake active in size within a few years. The firm expects that more than 50% of the money in equity strategies will be in passive funds in five years, compared with 43% today. If the current period of improved active performance ends, the market share of passive could top 60%, the firm wrote.

At the end of 2016, there was $9.3 trillion in all active strategies versus $5.3 trillion in passive, according to Morningstar, meaning passive strategies have about 36% of the market share.

Overall, Deutsche Bank expects total passive share—including bond and hybrid strategies—to account for 40% of the market in five years, or 50% if active performance doesn’t improve.

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