The rise of passive investment management in recent years has been staggering. According to JPMorgan, passive funds now account for 35% of all equity, bond and hybrid funds in the US, 17% in Europe and 22% in emerging markets.
However, when US-listed exchange-traded funds posted net monthly outflows for a third month in a row in June – the first time that this has happened since 2008 – many started to hear alarm bells. If the sector posts net outflows for July, this would be the first time there had been four months of outflows since the late 1990s.
Could the market volatility earlier this year have slowed the relentless march to passive? It certainly represented the first serious road bump that many ETF buyers have experienced. Retail investor inflows into both bond and equity ETFs have subsequently slowed down a lot, but it seems a little early to call for a wholesale rethink of the strategy.
Despite the recent outflows, US ETFs still saw $124 billion of inflows in June, taking total US-listed ETF assets under management to more than $3.5 trillion – up by 50% since October 2016. That is a lot of money.
There are other factors at work. Some of the outflows are the result of the reconstitution of the iShares Russell ETF indices. Seven of the 10 ETFs with the biggest outflows track these indices. The SPDR S&P500 ETF Trust was the worst hit, with net redemptions of $5 billion. Clients also pulled $22.4 billion from BlackRock’s equity ETF products in the second quarter of this year, while inflows into its iShares products were their lowest since the second quarter of 2016, at $17.8 billion.
The negative sentiment is very much concentrated in equity ETFs. Fixed income ETFs saw $7.4 billion of inflows during June – the 35th consecutive month of inflows to the sector. These were concentrated in government and short-duration corporates, however, with high yield having posted outflows for four months straight.
The shift from active to passive investing is far more advanced in equity funds than in bond funds, so recent outflows are also a sign of the maturity of the sector and just how much greater interest there is in equity ETFs than their fixed income cousins. Bond ETFs saw outflows after the taper tantrum of 2013 right up until the end of 2016, although there have subsequently been $160 billion inflows since early 2017.
The lure of equity ETFs can also be laid squarely at the door of poor active management. According to JPMorgan, the majority of active equity funds have only outperformed their benchmark in three of the last 10 years, while bond funds have done so in eight. It is no surprise, therefore, that equity investors have been eager to embrace passive investment vehicles and have done so in their droves.
The outflows since February are the inevitable consequence not only of volatility in the equity asset class itself but also of the sheer volume of money that has been deployed in this strategy. For bond funds, the march to passive has been far slower, so the volatility-driven pause will likely be more muted too.