October 28, 2020

Index funds clean up

by Dewi John.

Rather than flows between asset classes, the most dramatic moves over the past year have been in how UK investors choose to access them. The shift from active to passive within equity and bond funds has been greater than between asset classes.

We’ve looked before at the flows between asset classes over the course of the year, but not how it splits between active and passive. Investors have been using the dislocations in markets this year to increase passive holdings.

Chart 1: Active v Passive Fund Flows, £m, Q1-3 2020

Source: Refinitiv Lipper

Equity Flows

This trend is most pronounced with equities, where UK investors have put £11.8bn over the first three quarters of the year. However, this masks bigger swings between active and passive, with £17bn flowing into passive equity vehicles, while active ones have shed £5.2bn.

Table 1: The Biggest Passive Equity Money-Takers in 2020

Source: Refinitiv Lipper

The five top money takers have attracted more than £9bn between them, with £5.6bn going into three UK equities trackers, and the rest split between Japan and the US (table 1).Source: Refinitiv Lipper

Active equity mutual funds held £639bn of assets, with passives trailing at £269bn. Of that, ETFs are £20bn, which has been swelled by positive flows of £5bn over the year. So, while equity ETFs are a relatively small slice of the passive universe, they have seen stronger growth than their mutual fund equivalents over the year. The overwhelming majority of this—greater than for passives as a whole—has gone into UK equities.

Bond ETFs Head the Wrong Way

It’s a similar story with fixed income: the asset class has had an outflow of nearly £3bn over one year. But that masks a £4.2bn outflow for active, while passives have taken in almost £1.3bn. This is despite the well-rehearsed argument of active managers that passive fixed income investing is just giving your money to those companies carrying the most debt. Investors are clearly seeing things rather differently.

Table 1: The Biggest Passive Bond Money Takers in 2020


Source: Refinitiv Lipper

The main positive flows have been between broad UK and global investment grade indices. Gilts are much less in favour.

That said, active fixed income’s lead over passive still exceeds that of its equity equivalents, at £210bn versus £66bn, respectively, so passive bonds still have a lot more catching up to do.

Bond ETFs Head the Wrong Way

What is interesting is that bond ETFs have not, overall, benefited from this passive turn. There is about £10bn in passive bond ETFs, which is about 15% of the UK’s indexed bond fund market. These ETFs have shed £567m over 12 months. This contrasts with continental Europe, where bond ETFs posted their highest net inflows (+€25.9 bn) in 2020.

The three ETFs that have lost most—£746m in total—are all short-duration investment grade vehicles. Most of the money from these three headed out the door in February and March, when there was heightened anxiety about bond ETFs trading at excessive discounts to their NAVs. That the flow hasn’t been reversed is an indication that, as instruments to implement short-term views, no one is anticipating imminent rate rises.

What will be interesting, come the next major market drop, is whether investors will be more inclined to sit tight on the bond ETFs given they survived March’s turmoil. Have bond ETFs proven their durability, or was it just that central banks intervened in time?

… And the Rest

For real estate managers, the news has been unremittingly grim, whether active or passive, with outflows of £2.9bn and £109m respectively—just under 9% of assets under management. The real split with property is between UK Direct and Property Other, as we’ve looked at elsewhere.

Passive plays in Mixed Assets have yet to catch on despite the occasional flutter of hope in asset managers’ marketing departments. They add up to £2.4bn out of a total £405bn. Total outflows are £8.5bn—negative for both active and passive.

Money Market managers, however, can come break out the bubbly—budget cava, at least—as here, over the course of the year, passives have lost £15m and active managers have gained £102m. Although, as with others, there have been large gyrations in flows throughout the year.

The big moves for equity and bond passives have, unsurprisingly, been around large and liquid markets, indicating a growing scepticism in active management’s ability to reliably beat average returns.

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