This was written by Bloomberg Intelligence analysts Eric Balchunas and Morgan Barna. It first appeared on the Bloomberg Terminal.
A triple whammy for active mutual funds has arrived, with panicked investors, tax-loss harvesting by advisers and asset declines in a plunging market potentially pushing outflows to about $1 trillion by year-end. Without a broad turnaround, we believe the category could face $2-$3 trillion in asset losses and $15-$20 billion in lost revenue.
Record $356 billion in outflows in March
Active mutual funds had an estimated $356 billion exit in March, according to the Investment Company Institute. That’s by far the most ever in a month, indicating that investors had a pent-up desire to leave, and the market’s plunge served as a trigger. Outflows are likely to reach $500 billion by the end of April and – barring a market rebound – could end up at about $1 trillion by year-end as active funds’ mostly older investors cash out or tax-loss harvest into lower-cost indexed products.
While some flows will hinge on the direction of the market, we think secular and demographic trends will play a bigger role. Outflows would have been much higher had the Federal Reserve not stepped in.
Historical monthly flows for mutual funds
Repeating 2018, which repeated 2008
Barring a near-term reversal that lasts through year-end, we believe about $1 trillion could leave active mutual funds in 2020, while about $400 billion may enter index mutual funds and ETFs. The torrent of outflows from active mutual funds shouldn’t come as a surprise, based on past downturns. Despite the theory that active funds will shine in a sell-off and turn around the trend toward passive, the opposite has repeatedly been the case.
In 2008, active mutual funds saw $200 billion leave, while index mutual funds and ETFs took in $200 billion. The same thing happened in 2018, but the numbers were much larger.
Active vs. passive (Index MF + ETF) flows annually
Bull-market subsidy turns into bear tax
Outflows aren’t the only problem for active mutual funds. Market declines also are trimming their assets rapidly. This “bear-market tax” is the flip side to the “bull-market subsidy,” which allows for asset growth despite outflows. Equity mutual funds have been hurt much more than fixed-income peers, despite higher outflows for the latter.
Equity mutual funds lost almost $1.3 trillion in March, falling to $9.1 trillion in assets, thanks to stocks sliding almost 13% and $100 billion in outflows. Bond mutual funds shrank over $400 billion to $4.4 trillion – about $250 billion through outflows and $150 billion due to bonds falling 2-6%, depending on the category.
March trimmed $1.6 trillion off mutual-fund assets
Over $10 billion in revenue vanishes in month
Active mutual funds as a group saw about $10.5 billion in revenue disappear in March, according to our analysis, a figure that could climb to $20 billion by year-end depending on outflows and the asset impact from market declines. Stock-picking mutual funds had it worst, with about $8.5 billion in revenue lost due to a $1.3 trillion drop in assets, given an average 0.66% asset-weighted expense ratio. Fixed-income mutual funds lost about $2 billion in revenue via a $400 billion asset decline, with an asset-weighted fee of 0.49%.
The $10.5 billion in revenue is more than the annual total for the entire ETF industry, where revenue has also been reduced.
2019 bull-market subsidy working in reverse
Struggling to top passive benchmarks
Active mutual funds might arrest their asset decline by turning around performance, but they failed to do so in previous downturns. In 2008, during the financial crisis, about two-thirds of the most popular active equity mutual funds lagged behind their benchmarks – roughly the same as in any year, according to the S&P Indices Versus Active (SPIVA) scorecard. Of the 20 largest such funds at the time, 13 trailed and were unable to use their managing skills to cushion the market collapse. The 20 funds underperformed by 1.43 percentage points on average, a pattern repeated in every sell-off since.
Hedge funds with short positions tend to shine in such periods, rather than long-only active funds.
Top 20 active equity funds vs. index in 2008
