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A Look at the Road to Asset Parity Between Passive and Active U.S. Funds

A breakdown of passive and active funds’ asset parity in 5 charts

Tom Lauricella and Gabrielle DiBenedetto

 

With actively managed U.S. stock funds posting outflows in 11 out of the last 12 years, and an unbroken streak of inflows for passively managed U.S. stock funds, assets in index-tracking strategies have caught up with those in active funds.  

Our latest U.S. fund flows report shows that at the end of April, both passive and active U.S. equity funds had a total of about $4.3 trillion in assets, essentially reaching asset parity. 

The forces that have driven this trend show no sign of abating. Now, the question is the degree to which active management will remain the preferred destination for investors in other asset classes, such as international equities and taxable-bond funds. 

Below, we map out the trends in active and passive funds across the board. 

1. The move to passive strategies in stock funds 

The following shows the track for active and passive assets in U.S. equity funds. In this breakdown, the passive count includes both open-end funds and exchange-traded funds. 

At the end of 1998, there were 6.5 times as many assets in actively managed U.S. stock funds as there were in index funds. That ratio dipped below five times that by the end of 2000, the year in which iShares (then part of Barclays) rolled out its broad lineup of ETFs.  

U.S. Equity Funds Active vs. Passive Assets

2. The financial crisis shifted investor interest to passive strategies

2005 and 2006 were the last two calendar years in which actively managed U.S. equity funds had back-to-back inflows. As the chart below shows, the brutal bear market of the financial crisis appeared to change the landscape for good. Even though index funds had held the cost advantage, until then many investors still counted on stock-pickers to help beat the market while many active managers said they could offer better performance in market declines.

But the financial crisis inflicted huge losses on actively managed funds, including many well-known firms. Notably, U.S. stock index funds saw inflows in 2008, a year in which the S&P 500 lost 37%.

U.S. Equity Fund Flows

3. The growth of ETFs is creating competition for active managers 

Since 2015, roughly 200 U.S. stock ETFs have been introduced. While most flows go to just a handful of ETFs, the format has added competition for active managers, especially among investors who find the potential tax advantages of the ETF structure appealing. 

Open End and Exchange Traded Funds

4. The active-to-passive shift is occurring in tandem with a shift in asset allocations  

Within U.S. stock fund categories, the shift to passive has been accompanied by a shift in asset allocations within the Morningstar Style Box categories, mainly in terms of the flows to large-blend index funds, such as S&P 500 and total market products.  

The chart below shows that in 1998, large-blend funds composed about 34% of assets, with the passively managed portion of that group composing about 10%. Today, large-blend funds account for 44% of U.S. stock fund assets, with the passively managed segment accounting for about 33%. 

U.S. Equity Funds by investment Types

5. Active funds are sustaining their market share in other asset classes 

While passive funds have caught up with the active among U.S. equity funds, active funds continue to hold market share in other asset classes where information and trading are less efficient.  

For instance, among municipal-bond funds, 95% of assets are in active strategies. And as shown in the chart below from the Morningstar Active/Passive Barometer, investors still favor active funds among international stock funds and taxable-bond funds, even if the performance statistics don’t always bear out. 

Active vs. Passive Assets The  Research Portalmakes it easy to access Morningstar’s research and commentary from our expert teams of manager, stock, and credit analysts.  Get a free trial of Morningstar Cloud  to access more of the latest investment themes. All articles are available to current Morningstar Cloud subscribers.

 

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