This analysis is by Bloomberg Intelligence analyst James Seyffart. It appeared first on the Bloomberg Terminal.
Passive investing should sustain steady growth in the U.S. for the foreseeable future, in our view, with its market share on pace to overtake active within five years due to a widening lead in equities and expansion in fixed income. Bear markets have accelerated the trend, while active bond managers have proven best able to stem the tide.
Building on passive’s U.S. equity lead
Passive vehicles’ lead in the $11.6 trillion U.S. domestic equity-fund market will likely expand, we believe. Passive overtook active around August 2018 and its market share stands at about 54%, driven largely by the growth of funds tracking the S&P 500, the total U.S. stock market and other broad U.S. indexes. U.S. large-cap stocks are widely recognized as comprising the world’s most efficient equity market, contributing to passive’s dominance.
The $6.2 trillion in passive assets still accounts for less than a sixth of the U.S. stock market, with its market cap of about $40.4 trillion.
Active bigger in international, global equity
International and global equity funds were the only area where passive management lost market share over the past two years, but we expect that trend to reverse if overseas markets gain favor. Poor performance relative to U.S. stocks has limited investor interest and fund flows, giving an edge to active funds and their larger asset base. ARK’s active ETFs also fall into this non-domestic category, and their high inflows help suppress passive’s growth.
Active non-domestic equity funds hold about $2.36 trillion vs. passive’s $1.67 trillion. Yet if flows were to stall, a theoretical across-the-board one-year return of 10% would expand active’s notional lead to $760 billion from the current $690 billion due to the market subsidy.
Performance edge supports bond managers
Fixed income is one area where active managers still dominate, being widely viewed as more likely to provide alpha in a more complex and less-efficient market. Data provide some support, with bond managers historically beating indexes at much higher rates than equity peers. Still, we expect passive’s share of the bond market to continue to rise slowly as smart-beta funds become more popular and better able to compete. The growing trend of advisers actively managing portfolios using passive ETFs and mutual funds also provides a boost.
Given that some of the biggest holders of passive fixed-income ETFs are active managers, some assets may be double-counted.
Rising tide of passive across U.S. Funds
It’s only a matter of time before passive assets overtake active in U.S.-based mutual funds and ETFs. The 42.9% of assets, or about $10 trillion, managed passively are up from 31.6%, or $4.1 trillion, at the end of 2015. Discretionary active funds handle the remaining 57% — about $13.3 trillion of the $23.3 trillion in total fund assets.
Since 2013, passive’s share of U.S. fund assets has grown about 2.3 percentage points a year on rising prices and inflows, alongside broader outflows for active funds. If this trend continues, passive investing could overtake active within five years.
U.S.-listed equity funds exceed 50% passive
Passive vehicles hold 50.2% of U.S. publicly traded equity fund assets: 53.8% of domestic and 41.5% of non-domestic. The domestic fund market is almost 3x the size of the non-domestic one, at $11.6 trillion vs. $4 trillion.
