Passive funds see their worst month of outflows on record ______

Rising fears over inflation and interest rates, as well as worsening disillusion with UK assets, drove net selling of equity funds in October for the first time in fifteen months, according to the latest Fund Flow Index (FFI) from Calastone, the largest global funds network. Savers cashed in a net £148m of their equity fund holdings. This is small in the context of total trading volume of £20.5bn, but it pushed Calastone’s FFI:Equity to 49.6[1], its worst monthly reading since July 2020.

The outflow was driven by passive equity funds, which saw record outflows of £709m

Passive equity funds bore the brunt of the selling, suffering record outflows of £709m, almost five times larger than the previous record set for outflows from passive funds in July of this year. Inflows to passive funds easily outpaced active funds almost every month for 2.5 years until November 2020. But in ten of the last twelve months, passive funds have either attracted less new capital than active funds or seen outflows when active flows have been positive.

Investors can choose funds with a particular geographical focus. Global passive equity funds suffered the worst outflows (-£716m)[2], but flows were negative across all major geographies except emerging markets. UK-focused passive funds were the second-worst hit, with a net outflow of £226m.

UK-focused equity funds were hit hard by second-worst outflows on record

Unlike most other geographies, the bad news for UK-focused equity funds was not limited to passive funds, however. UK-focused active funds shed £393m too, making the total net outflow from UK-focused equity funds £618m in October, the second worst month on record. Moreover, the month saw the fifth consecutive month of outflows in UK-focused equity funds, a run of selling that no other geographical category of equity fund has seen this year.

Active flows overall were strongly positive thanks to ESG

Most ESG funds are actively managed, though this is beginning to change. They also tend to have a global focus.[3] Active ESG equity funds remain the runaway success story among all active funds. They enjoyed £568m of inflows in October taking the total year-to-date to £8.0bn. Most of this has been devoted to active global ESG strategies. The October inflow was large enough to offset outflows from other active categories that did not have ESG mandates. Inflows to active funds of all kinds totalled a net £561m.

Fixed income inflows declined while real estate outflows remained steady

Fixed income funds are often a beneficiary when equity funds see outflows. But with rising inflation also bad for this asset class, inflows fell to their second-lowest level in more than a year. Nevertheless, there were inflows, totalling £327m in October. Outflows from property funds were £85m, in line with the previous four months.

Edward Glyn, head of global markets at Calastone said: “Share prices globally had a pretty good month in October after a shaky September, so it’s perhaps surprising that investors pulled money from a rising market. They have some good reasons to be nervous. Spiking inflation and higher bond yields are bad news for the valuations of growth companies. The net outflow we saw in October was by no means a rout, however, and it may simply point to modest profit taking at a time of record share prices.

Moreover, the picture is being exaggerated by the particular distaste UK investors are showing for their home market. Some of this is part of a healthy long-term trend of rebalancing[4] portfolios away from a structural overweight in domestic stocks, but this rebalancing is normally achieved by simply putting new cash elsewhere rather than outright selling. The current picture can only be explained by a loss of confidence in the UK’s prospects as quantified in the OBR’s recent assessment of the damage being done by the pandemic and Brexit.

The active v passive tussle certainly took on a new perspective. Investors have lost interest in passive funds over the last year, but October was the first month on record when outflows from passive funds were larger than inflows to active ones. Some of this relates to concerns over equity prices – passive funds tend to do worse than active ones when markets fall. But ESG is clearly a big issue too. With climate change dominating the headlines, and with some of the world’s most polluting industries taking a large share of global (and especially UK) market capitalisation, investors are perhaps realising that passive funds often don’t meet their growing need to align their investments with their world view. This is likely to change as the passive fund industry launches more funds that track ESG benchmarks – we are already seeing that – but for now, the active industry is streets ahead.”

[1] The FFI compares the net flow of funds to total trading activity and a reading of 50 means buying activity balances selling

[2]The net outflow from global passive funds is more than the net outflow from all passive equity funds because some categories saw inflows

[3] ESG funds can be actively or passively managed and they can be global, UK, European etc. ESG cuts across these other categories so you cannot add all the figures in this press release together. We have cross-cut them for you where relevant.

[4] Average monthly inflow to UK-focused equity funds since 2015 has been £33m; Average monthly inflow to funds focused on overseas equities has been £555m over the same period

METHODOLOGY

Calastone analysed over a million buy and sell orders every month from January 2015, tracking monies from IFAs, platforms and institutions as they flow into and out of investment funds. Data is collected until the close of business on the last day of each month. A single order is usually the aggregated value of a number of trades from underlying investors passed for example from a platform via Calastone to the fund manager. In reality, therefore, the index is analysing the impact of many millions of investor decisions each month.

More than two thirds of UK fund flows by value pass across the Calastone network each month. All these trades are included in the FFI. To avoid double-counting, however, the team has excluded deals that represent transactions where funds of funds are buying those funds that comprise the portfolio. Totals are scaled up for Calastone’s market share.

A reading of 50 indicates that new money investors put into funds equals the value of redemptions (or sales) from funds. A reading of 100 would mean all activity was buying; a reading of 0 would mean all activity was selling. In other words, £1m of net inflows will score more highly if there is no selling activity, than it would if £1m was merely a small difference between a large amount of buying and a similarly large amount of selling.

Calastone’s main FFI All Assets considers transactions only by UK-based investors, placing orders for funds domiciled in the UK. The majority of this capital is from retail investors. Calastone also measures the flow of funds from UK-based investors to offshore-domiciled funds. Most of these are domiciled in Ireland and Luxembourg. This is overwhelmingly capital from institutions; the larger size