by Jake Moeller.
I’m on the record as saying 2018 could be a good year for active funds. Typically, late-cycle environments precede a rotation out of momentum-biased ETFs and the increasingly expensive large-cap stocks they invest in, providing fertile ground for active stock pickers.
It is quite difficult to know where exactly we are in the cycle and just how late in fact we are in it, but there is no doubt that flows into passive funds in Europe and the U.K. have been buoyant over the last few years.
Lipper data reveal that the average annual percentage of passive pan-European net fund flows (ETFs and tracker funds) of total net fund flows was a modest 5% from 2004-2014. However, in recent years there has been a structural shift in this average. For 2015 passive vehicles had a huge year, constituting 32% of total net fund inflows. For 2016 this figure fell to 24%, and for 2017 the figure was 18%—all well above that longer-term average of 5%.
A receding tide floating only passive boats
However, data to the end of Q3 2018 reveal a comparatively poor year for both active and passive vehicles. For this period there have been net inflows for all types of funds of only some €6 billion (compared to total net inflows for 2017 of nearly €800 billion). See Figure 1 below.
Figure 1. Pan-European Estimated Net Flows, 2004 to Q3 2018 (in € billion
Active funds have had net outflows of €44.0 billion, and passive vehicles (index funds and ETFs combined) have had net inflows of €56.4 billion. So, it appears that unless active funds have a record-breaking final quarter in 2018, they will be unable to keep their heads above water–as in 2008 and 2011.
Performance-wise for Q3 2018, passive vehicles are fairly well ahead of their active counterparts.
Figure 2. U.K. Performance
Only 34% of active funds in the Lipper UK Equity classification beat the highest ranked broad-based tracker over the period. In the Lipper Europe ex-UK classification the figure was lower, with 25% of active funds beating the highest ranked broad-based tracker fund.
Figure 3. Europe ex-U.K. Performance
For the Lipper US Equity classification the figure was 31%. The longer-term performance periods to the end of 2017 are not particularly stellar. But, perhaps surprisingly in the competitive U.S. market at least, active funds up to Q3 are doing better than in the longer-term data.
Figure 4. U.S. Performance
Opportunity cost is still material
When it comes to performance comparisons, it is important to consider the “opportunity cost” of not investing in an active fund (i.e., the potential outperformance of a fund over an index). Often this can be considerable. The orange bars in each of the graphs show this. For example, in the five years to the end of 2017 the best performing active fund in the Lipper UK Equities classification outperformed the highest ranking broad-based tracker by around 105 percentage points—not inconsiderable.
For Q3 2018 the comparable spread over the period is 11 percentage points. There are certainly some active funds doing well, just not that many of them.
A tough market for all–especially active funds
On the face of it the period to the end of Q3 2018 has been fairly nondescript for active funds in aggregate. However, compared to the record year of 2017, it is a tough market in Europe for all fund providers, both passive and active.
I remain an advocate of active funds and believe we could still see an improvement of relative data by the end of the year. I don’t lose sleep over short-term data, but I will concede there is much room for improvement in the final quarter of 2018.
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