PA ANALYSIS: Time for active funds to adapt or die

The active funds industry must shrink, cut prices, better-align itself with investors and differentiate if it wants to compete against a passive onslaught, according to a report by Morningstar.

PA ANALYSIS: Time for active funds to adapt or die

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Jeffrey Ptak, head of global manager research at Morningstar, notes that just three years ago actively managed funds accounted for 72% of US open-ended and ETF assets. As at the end of May 2017 this had fallen to about 63%.

Indeed, given the structural shifts which are taking place in the market, hastened by regulation and investor preferences, he argues that within the next decade it is not unreasonable to think that passive funds will take another 10 percentage points of the market share.

Translating this into fund flows, Ptak says that in the US, passive funds, including strategic-beta ETFs, recently held about $6.2trn of the $16.5trn in US fund assets. He says that given a semiconservative 4% annual organic growth rate in the US fund industry for the next decade, it would vault passive assets to about $11trn by 2027.

Depending on assumptions for sources of future growth, he says this would imply at least $1trn in outflows from active funds.

While this study relates to the US funds industry, many of its conclusions cross over into the UK market. It was only very recently that the FCA released the findings of its Asset Management Study which called for active funds to lower their fees to provide better value for investors.

One of the conclusions this has lead to is that there may be a wave of fund consolidation of small, poorly performing funds, as group’s feel the eyes of the regulator on them to justify the fees they are charging.

After how UK funds performed in 2016, it no surprise they are under the spotlight. Tom Becket, chief investment officer at Psigma Investment Management, notes that just 16% of funds in the IA UK All Companies sector (42 out of 259) managed to outperform the FTSE All-Share Index.

With these funds charging ongoing charge fees (OCFs) of 75bps and upwards, it little surprise that as in the US, there has been huge a growth in the use of cheaper passive funds in recent years. However, Becket suggests that strong performance at the start of this year, suggests that active funds in the UK could be set for a turnaround in their fortunes.

“Of course it is premature to state it conclusively, but the first half of 2017 might well have seen the start of a revival or a renaissance for active equity funds in the UK,” says Becket. “The cynics (me among them) would say it was long overdue after a mostly dismal 2016 (and in some places over the longer run), but there are signs a corner has been turned.” 

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