In the second half of 2022, investors are having to navigate a multitude of risks – recessions, inflationary surges and interest rate hikes. The volatility created in markets has turned some against passive funds.
Back in April, Investment Association (IA) data shows tracker fund assets under management as £293bn after £1.5bn in net retail inflows that month alone. Fast forward to the most recent data, and as of June passive AUM stood at £277bn with £41m in net retail outflows being recorded that month.
Despite some of these stats, sentiment is not against passives outright, according to Chris Chancellor, vice president of distribution insight at Broadridge Analytics Solutions. He points out that passive funds continue to attract flows year to date – crucially their cost is not the only deciding factor.
“Fees are a factor but so is the speed to allocate money. As investors try to position their portfolios it can be the case that passives are used for quick allocation decisions – while active funds are in outflow,” says Chancellor. “It’s worth remembering that active funds may be older than passive funds and they will therefore have a higher rate of natural attrition.”
Sensible shift in messaging from advisers
Passives have shown a greater resilience in some portfolios than their active counterparts. Billions have been removed from funds of both disciplines, with passives actually demonstrating greater sticking power.
This points to a continued shift towards passives, according to Nick Blake, Redington managing director, wealth.
“A change of investment philosophy among advisers is one cause – there’s been a sensible shift in messaging away from ‘my job is to beat the market for you’ to ‘my job is to get you to your goal,’” says Blake.
“Nevertheless, undoubtedly, an increasing focus on cost has also been a key driver. Advisers are looking to bring overall portfolio costs down, especially as portfolio returns are squeezed. Over time, Consumer Duty and an increased focus on value for money will further fuel a focus on costs.”
Where the passive money is moving
There are identifiable trends in where passive funds are attracting the greatest flows. Using data from FE, and removing ETFs, Tom Poulter, head of quantitative research at Square Mile Investment Consulting and Research, has found clear deviations between active and passive funds across the IA Global, UK All Companies and Sterling Corporate Bond Sectors.
| Global | 2019 | 2020 | 2021 | 2022 ytd |
| Active | -£11,020,238,144 | £18,679,609,643 | £12,486,137,340 | -£12,347,277,927 |
| Passive | £1,045,110,806 | £2,520,036,631 | £5,597,057,875 | £4,794,915,970 |
| UK All Companies | 2019 | 2020 | 2021 | 2022 ytd |
| Active | -£6,822,294,245 | -£17,898,996,579 | -£17,625,081,331 | -£12,132,306,603 |
| Passive | £3,290,200,818 | £7,090,056,905 | -£3,984,021,296 | -£5,317,179,510 |
| Sterling Corporate Bond | 2019 | 2020 | 2021 | 2022 ytd |
| Active | -£3,496,308,717 | -£692,091,940 | -£4,789,748,102 | -£7,888,518,794 |
| Passive | £2,869,417,412 | £917,983,836 | £1,653,818,325 | -£1,335,467,895 |
Source: FE (2022 data YTD 31/7/2022)
“Some of the flows will obviously be driven by sentiment towards the asset class, however it’s easy to see that passive funds appear to be in more constant net inflows compared to active funds where the flows are more variable,” remarks Poulter.
“The performance of a passive fund is based on its asset class performance. Year-to-date the majority of all asset classes have provided negative absolute returns. From a relative perspective UK equities and especially UK large caps have performed well, while UK gilts and emerging market equities have performed poorly.”
ETF flows support risk-off sentiment
Taken into context the challenging macroeconomic environment, Invesco’s ETF head of product and sales strategy (EMEA) Matthew Tagliani says flows simply reflect attitude to risk.
“Many of our investors tell us they still view this as a risk-off environment, and the flows support that,” he says.
“Looking at the year-to-date flows, equities have taken in around three quarters of all ETF net flows – this bias would seem to indicate a greater appetite for risk, but equities are a larger share of ETF AUM overall, so three quarters participation is pretty much in-line.”
Instead, Tagliani says flows within asset classes are more telling – especially where capital has been rotated out of riskier assets.
“In fixed income, for example, US Treasury funds have seen the strongest flows, while areas like China bonds and high yield have seen outflows,” he explains. “Interestingly, despite record high inflation data, inflation-linked ETFs have seen sharp outflows as investors appear to believe the market has already priced in the worst.”
Active’s time to shine?
When analysing passive strategies, it is natural to draw comparisons with active funds. Active funds have also been suffering significant outflows in 2022 and commentators could argue this is their managers’ time to outperform and justify higher fees.
This comparison (and expectation) is simplistic, according to Chancellor, who points out headlines about outflows and inflows will not blanket apply to all funds in a given discipline.
“Certainly, many investors continue to believe that active funds can navigate well in challenging times. In reality, for most investors it isn’t either active or passive but active and passive,” he says. “Where they believe an active manager can use skill to reduce risk and create returns, they will use active and in other areas they may use passives.”
Increasingly, investors have come to challenge active funds with a wealth of data at their disposal dismissing the myths around this. This – along with statements from the Financial Conduct Authority about the apparent lack of value being offered by active asset management – has created greater apathy among investors. But active funds can still hold a place in portfolios, says Redington’s Blake.
“Investors should consider active fund performance over the longer term,” he says. “Talent is clearly important in active management, but so is managing costs and having patience. This is certainly the case for high-conviction managers following a particular strategy.”
Invesco’s Tagliani says actives can shine through, but it is a case of blending these with passives – instead, putting the onus on portfolio construction decisions. Importantly, he argues the theory of active managers benefitting from volatility and triumphantly outmanoeuvring falls is something investors should be sceptical about.
“There’s a common misperception that just because markets are more volatile that this benefits active managers,” he says. “Stockpickers benefit from dispersion – that is, a market where some stocks go up and others go down – because that increases the benefit of owning the ‘right’ stocks. But if stocks all behave similarly, it matters less which one you own and more how you time taking on market exposure as a whole.”
