In a remarkable turn of events, actively managed equity funds suddenly saw substantial inflows in May, after months of steady outflows. At the same time, investors left index trackers in droves.
Over the past few years, it seemed the market share of ETFs could only go up. In May however, actively managed equity funds saw net inflows of no less than €12 billion, while their passive counterparts faced net outflows of €2.3 billion, according to Morningstar data. A similar monthly flow pattern occurred only four times before this decade.
‘The inflows into active equity funds in May was driven mainly by strong demand for technology, healthcare and growth funds,› says Morningstar analyst Ali Masarwah. As was the case in April, money continued to flow out of broad equity funds. Active funds also suffered, but some large ETFs in particular saw substantial outflows. Such as the Vanguard S&P 500 ETF, which suffered redemptions of €554 million.
Volatility
Yoram Lustig, head of multi-asset EMEA at the active asset manager T. Rowe Price, believes that the increased market volatility since the outbreak of the corona pandemic has led to a revaluation of active management. ‘We hadn’t had a serious bear market since 2011. So the enormous volatility of recent months has been a wake-up call for many investors. They now realise once more that passive funds do not offer you any protection when markets go down.’
A active managers have had difficulty generating outperformance after costs during the past decade due to a continuing lack of volatility. ‹But in an environment of higher volatility such as we are experiencing now, things are different. The economic and social changes accelerated by the coronavirus are a golden opportunity for active managers,› according to Lustig.
He therefore expects the comeback of active managers to continue. Or is it hope rather than expectation? The recent allocation moves don’t seem to be so much about a rotation from passive to active, but rather a move from market beta to specialised strategies. And to speak of a trend goes way too far: over the past 12 months, investors have still channelled more than €50 billion to index trackers.
Wim van Zwol of the mainly passive investment house Vanguard does indeed dismiss the flight from passive equity funds as a «one-off». ‘It may well be that it’s just a few large investors, for example banks, who have reduced their allocation from overweight to neutral in one large transaction,’ he ponders. ‘The highest outflows came from the Vanguard S&P 500 ETF, which is precisely a product that often records large transactions. This year this ETF also had positive inflows overall, so I don’t think we’re really seeing a tipping point here.’
Management fees
Ultimately, the much lower management fees is the main reason for the increasing popularity of passive investing. And the coronavirus crisis doesn’t change this dynamic. And because of the expected lower returns in the future, management fees will weigh even more heavily on net returns.
But T. Rowe Price’s Lustig sees this in a different light. ‘In the future, you may be able to achieve a return of 5% on equity investments, while that used to be 8-10%. Where you used to get a 10% return plus 2% alpha, now it might be a 5% return plus 2% alpha,’ he argues. ‘As such, the share of alpha in the total return increases, and so does the importance of active management. This makes it easier for active managers to justify their management fees.›
Provided, of course, that they actually deliver this alpha. If they do not, the recent uptick in flows to active equity funds will probably soon turn into outflows again, and ETFs will resume their advance.