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Death of Active?

Data doesn’t necessarily support the notion that investors have gotten religion about passive investing.

Jeffrey Ptak, 10/23/2014

This article originally appeared in the October/November 2014 issue of Morningstar magazine. To subscribe, please call 1-800-384-4000.  

One of the biggest stories of recent years is the rise of passive investing. In June 2009, active funds accounted for about 79% of fund assets (active U.S. stock funds had a 31.7% market share). Fast forward five years, and that figure had shrunk to 71.5% (28.7% for U.S. stock funds), the incursion by passive funds accounting for the 7.5% erosion. That’s a big number.

On balance, the shift looks like a big positive. Studies have shown that cost is one of the few variables that can predict future relative performance, so perhaps the move to passive means investors have become more frugal in trying to boost their odds of success. Or maybe they’ve changed their priorities, focusing less on chasing the hot actively managed fund of the moment and more on using ETFs and index funds to lock-in a suitable asset allocation (which, in my opinion, is what really matters anyway). Whatever the reasons, it looks like a step in the right direction.

Laudatory as that is, however, the active/passive debate tends to get framed as a moral parable, in which investors have had their moment of revelation and clarity. By this telling, it’s all over for actively managed funds. Put a fork in ‘em. They’re goners.

Here’s the thing, though: The data doesn’t unequivocally support the notion that investors have gotten religion about costs or totally lost their faith in active investing. In fact, when we burrow into the data, we find a number of trends that raise questions about, if not contradict, those assertions. To wit:

American Funds, a large actively managed fund complex, accounted for a disproportionate chunk of the market-share erosion and outflows that active funds have suffered. American is a striking example given that its funds are cheap and many boast solid long-term records.

Actively managed large-cap funds also were the source of outsized redemptions, large-growth offerings in particular. Passive funds have made their biggest inroads to U.S. equities. Yet, active foreign-stock funds didn’t lose as much share, a curious divergence.

Investors do not appear to have been uniformly repulsed by pricier active funds; alternative funds, for example, gained market share. On the flipside, some low-cost active funds, like municipal-bond funds, lost meaningful market share, despite there not being a ready passive substitute.

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