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Eric Balchunas

A Bear Market Would Be a Death Knell for Active Funds

A downturn would give investors sitting on big tax gains an excuse to get out, possibly taking some $1 trillion with them.

The mutual fund business may soon change forever. 

The mutual fund business may soon change forever. 

Photograph: Bloomberg

Be careful what you wish for. While it is tempting for fund managers to root for a downturn so they can show investors why a human hand is better than the "dumb" passive index mutual funds and exchange-traded funds that investors have flocked to, it would actually be the worst possible situation for them and likely result in a messy and hurried consolidation of the entire industry like nothing we’ve seen before. 

First, it would severely damage the one thing that has protected active managers against the $7 trillion shift into low-cost index funds and ETFs: a big asset base. A big base in a bull market is not just a bulwark against outflows; it is a virtual money printing machine. In the past four years almost $1 trillion has come out of active equity mutual funds, including in 34 out of the last 35 months, yet their assets have increased by about $1 trillion over that time period to $6.5 trillion. So, despite losing about 20 percent of their deposits, they saw fee revenue increase from about $40 billion a year to $45 billion thanks to epic stock market returns.