Passive funds build on their momentum______

Edward Glyn, Head of Global Markets

Index trackers are demonstrably winning the battle for new capital against active fund managers, although inflows into ESG funds are seemingly keeping the industry afloat, according our latest global Fund Flow Index -“Tidal forces: Can active funds fight the passive flows?”

A shift is underway in the funds industry as passive products increasingly capture active management share. Although active management fees fell by 15% from 1.13% to 0.95% between 2017 and 2021, passives are still much cheaper – often charging around 0.1%. Client disquiet over fees comes at a time when active management performance – relative to that of passives – is under growing scrutiny. Despite actively managed large cap UK equity funds outperforming their passive equivalents in the final six months of 2020 – producing average returns of 8.3%, versus 5.1% for passives – actives have struggled to generate decent performance over the long-term. According to analysis by S&P Dow Jones, 85.1% of large cap active fund managers underperformed the S&P 500 over the last 10 years, and this rises to 91.6% for the previous 15 years.

Our latest global Fund Flow Index (FFI), which analyses the millions of buy and sell orders that take place across our network, found that index trackers attracted $10 billion in inflows in 2019, and a further $13.5 billion in 2020. The value of buy-orders for index trackers was almost two fifths higher than sells over the two year period. Across all markets and equity fund categories, our indices of passive funds have outpaced their active equivalents over the last two years. In contrast, active funds suffered net outflows totalling $11.4 billion in 2019 and they would have incurred further losses in 2020 had it not been for their strong recovery in the final quarter following the COVID-19 volatility in Spring. By November 2020, active managers had recouped all of their earlier outflows, attracting $6 billion in new capital at year-end.

Our report also noted some significant geographical variations in terms of the inflows going into passives. In the UK, investors withdrew $400 million from active funds between 2019 and 2020, and allocated $17.3 billion to index trackers. In contrast, we found other markets such as Australia and Singapore saw significant growth in their active management markets. In the case of Australia, inflows into active funds totalled $3.7 billion in 2020 compared to the $943 million which entered into passives. Over the last two years, active flows in Australia have been three fifths higher than that of index trackers. Even with this being the case, we have rated the passive flows higher in Australia because they took place on lower overall transaction volumes, indicating greater investor conviction. To this extent, Australia follows the global trend. Despite this, all is not lost with active managers increasingly capitalising on the growing investor appetite for ESG products.

Moving into an ESG world

ESG equity funds are eliciting enormous interest from investors. Our data found that $84 in every net $100 flowing through our network of equity funds is now going into ESG products, corresponding to around $15.1 billion out of $18.1 billion. Three quarters of this new ESG capital ($11.3 billion) flowed into active funds, which is proving to be a lifeline for active managers. If we remove ESG funds from our dataset, then traditional active funds would have shed $16.8 billion over the last two years. A lot of the demand for ESG is being driven by UK and European investors. In the last two years, large numbers of European investors have switched from non-ESG funds to ESG funds, selling $7.5 billion of the former and acquiring $4.3 billion of the latter. However, demand for ESG products among Australian and Asian investors appears to be around two to three years behind the curve.

The increased investor appetite for ESG funds can possibly be explained by the asset class’ strong performance relative to non-ESG funds. A study by Willis Owen found ESG funds on average delivered returns of 22.3% in 2020, versus the IA Global sector average of 13.2%. In the context of COVID-19, it is likely that interest in ESG products is only going to surge. A report by Aviva revealed that 55% of investors said the pandemic had an impact on their likelihood to take ESG factors into consideration when deciding on how to invest their money. New regulations – at least in Europe – together with  changing investor demographics have also been major influences. Many millennials take a keen interest in ESG, and are adopting socially responsible-based approaches towards investing. In one of our recent surveys looking into global investor behaviour, we found that three quarters of millennials prioritise ethics when choosing investment funds. A survey by Morgan Stanley of high net worth investors found an even higher 95% of millennials were interested in sustainable investing. A growing number of forward-thinking managers are taking note of these developments by launching ESG-focussed funds.

Responding to change

While passive fund products are accumulating market share, active equity funds are fighting back. Many active managers are increasingly manufacturing ESG products, conscious that it is an asset class whose performance is in an ascendency, which in turn is leading to growing investor interest.

If active managers are to retain their dominance at a time when they are under exceptional pressure from passives, they might do well to incorporate or develop ESG investment solutions.


Edward Glyn, Head of Global Markets


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