We believe it’s a great time to be an active manager.
Today, there’s $11.7 trillion in actively managed funds. That’s a huge increase from the first quarter of 2009.
But there may yet be a reckoning. Over the trailing 12 months ended in September, 66% of actively managed U.S. equity funds were in outflows. In our opinion, that’s remarkable considering the tremendous bull market. Across all asset classes, about $410 billion left actively managed funds from the start of 2015 through September 2018. However, that was overcome by strong returns. The S&P 500 gained 50% over that same time period and has nearly tripled since the start of 2009.
So far, then, flows aren’t much of a problem. But we believe the industry is very vulnerable to a bear market. If the market falls 30% and outflows accelerate to 25%, then you are likely looking at a tremendous decline.
We believe another troubling sign for actively managed funds: Until recently, the move to passive had been contained within domestic equity. However, in the third quarter, passive international-equity funds saw $19 billion in net inflows, and active international-equity funds suffered $15 billion in net outflows. Passive funds from Vanguard and Fidelity (which launched zero-fee index funds) are big draws of late, while other active funds have been hit hard. It could be a blip or the start of a trend.
While outflows can be bad for the industry, we believe there are some positives for investors:
- Morningstar Medalists small-cap funds remain open: Normally at this stage of a bull market, these actively managed small-cap funds would be closed in order to keep asset size from harming a manager’s ability to execute his strategy.
- Bloated large-cap funds are getting less bloated: The 20 largest actively managed funds across all asset classes cumulatively have shed about 20% of assets under management over the past three years. If investors want to give more wiggle room to managers of some giant funds at American Funds, Fidelity, and Vanguard, then I’m all for it.
Of course, there are some negatives:
- Fees may rise: Of course, economies of scale work in reverse, too. Outflows can lead to higher expense ratios.
- Redemptions can hurt performance: Small-cap, high-yield, and bank-loan funds all have limited liquidity, and outflows can cause a performance slump as managers have to sell so much that it drives down the price of the securities they are selling.
- Asset-manager mergers will accelerate: Fund companies will likely feel the pressure to merge as they find themselves with excess capacity and reduced profitability. We believe they will naturally look to merge with firms that have complementary strengths.
In our opinion, flows will be a huge part of the story at nearly every fund and fund company, especially when the next bear market arrives. We’ll be watching closely.
Please see below for important disclosure.