Correction or Turning Point

At $685 billion, cash flows into long-term mutual funds and ETFs hit a new record in 2017. While actively managed bond fund flows enjoyed healthy gains in the year, overall investors’ love affair with passive vehicles continued unabated. Indexed domestic equity funds grew by $220 billion, an amount just about evenly matched by continued outflows from actively managed domestic equity funds. In a stellar year for international equities, the $35 billion in active fund inflows was dwarfed by nearly $240 billion into passive options. The chart below from Morningstar illustrates the longer-term accelerating trend toward passive investing.

Investors’ growing interest in index products has been driven largely by performance. In an environment of steadily rising markets and low volatility, as shown in the chart below, higher cost active managers on average have simply not been able to keep pace with their passive counterparts. Over time, as the performance advantage of passive has persisted, the supporters of active management, particularly in core asset classes, have declined.

It will be interesting to see how soon and to what degree recent market volatility impacts the trend to passive and whether active managers can take advantage of more volatile markets shouldthey continue.