Tuesday, August 07, 2018 /10:50AM / Moody’s Investors Service
Outflows of dollars invested in US active equity mutual funds have accelerated in 2018 and are now at their highest year-to-date rate. According to ICI data on long-term domestic equity funds, which we use as a proxy for active mutual funds, outflows from active equity funds totaled $129.11 billion as of 31 July, up from $99.88 billion a year earlier and $110.62 billion for the similar 2016 period (see Exhibit 1). This deterioration in market flows is credit negative for active US equity managers such as GAMCO Investors, Inc. (Ba1 stable), BrightSphere Investment Group plc (Baa2 stable) and Janus Henderson Group Plc (Baa2 positive).
Rising equity markets have masked the underlying weakness of many traditional asset manager business models, which have come to rely on asset market appreciation in recent years as flows into higher-fee funds remain elusive. As equity market values have risen over the past decade, asset managers have experienced stable cash flow generation. However the lack of organic AUM growth at a time when asset markets are at historical highs is a cause for concern.
Additionally, the continued decline in fee trends is worrisome for asset managers. The average active equity fee net expense ratio has declined below 60 basis points, as calculated by ICI, and active bond funds' expense ratios have declined below 50 basis points.
Because investors’ shift toward passive products and the continued net expense ratio deterioration of high-fee products are trends that appear to be accelerating, asset managers are more susceptible to equity market volatility and elevated valuations.
The forces causing the shift of assets from higher-fee active products to lower-fee passive products persist. We view the movement of assets into lower-fee passive products as a low-tech form of technology adoption. That is, the underlying causes of this shift are independent of macroeconomic or financial market trends. Instead, this dynamic is largely attributable to shifting consumer preferences for transparent, efficient and lower-cost products, similar to the way a particular technology or innovation diffuses within a marketplace.
Although some market participants have argued that equity volatility would provide the need for investors to hold active funds, active managers did not generally outperform during the equity market volatility of first-quarter 2018. Instead, the performance of active funds was in line with historical behavior. In the first half of 2018, following the market turbulence in the first quarter, JPMorgan estimated that only 41% of active fund managers surpassed their benchmark year to date, compared with 52% a year earlier.