The Battle of Passive vs. Active Reaches New Milestone

December 5, 2023 — Boston

Passive mutual fund and ETF assets will surpass active, but the flight toward passive may be slowing

Cerulli projections indicate that total passive mutual fund and exchange-traded fund (ETF) assets will surpass total active mutual fund and ETF assets by early 2024, according to U.S. Product Development 2023: Resource Reallocation Through Product Rationalization. However, the flight toward passive may be slowing, as active management seeks ground in vehicles other than the mutual fund.

Approximately 10 years ago, passive mutual funds and ETFs were neck and neck in the asset race against each other, while they collectively held one-quarter of the marketshare of total mutual fund and ETF assets. Since then, passive assets in the two vehicles have stolen one to three percentage points of marketshare from actively managed assets each year, reaching 49% of marketshare as of the end of 2Q 2023.1

However, the gains in passive marketshare may not represent the full story. Passive management primarily exists only within mutual funds, ETFs, and collective investment trusts (CITs). According to the research, looking across mutual funds, ETFs, CITs, money markets, retail separately managed accounts (SMAs), and alternative structures, active management still holds 70% of marketshare as of the end of 2022 and the pace of outflows has slowed in recent years.

As the industry looks into the future, questions persist regarding how much marketshare passively managed assets will eventually control, and whether the trend toward passively managed assets will slow based on changing economic conditions and investor preferences. “Time will tell where the critical point exists upon which passive investing becomes a risk, where the mechanism of blindly buying securities based on their prices rather than their cash flow could blow back,” says Matt Apkarian, associate director.

Performance aside, the drivers of demand for active and passive are based on attitudes toward management styles, and the belief or lack of belief that active managers can outperform in various market environments or over full market cycles. Geopolitical shock (73%) and recession (69%) are the scenarios most believed to increase demand for active management, while a sustained equity bull market (50%) is the scenario most believed to decrease demand for active management.

“Expansion of strategies and allocations outside of the largest U.S.-based asset classes can stand to give support to active management, as assets appear to be on a path to continue moving into passively managed products within the portfolio core of U.S. equity and fixed income,” adds Apkarian. “Asset managers must adapt to changing demand from financial advisors and end-investors to remain relevant in the industry. Increased focus on defined outcome products with better downside capture can serve to be the tool that meets advisor needs when attempting to provide their clients with a smooth ride toward their financial goals,” he concludes.

1 Source: Morningstar

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