Blog Posts — July 27, 2018

Passive Strategies and the Ageing Bull Market

By Roberto Lazzarotto, Global Head of Sales, STOXX

IPE’s latest Top 400 Asset Managers survey1 of the largest institutional money managers sheds light on the increasing popularity of index-based strategies: passively managed assets grew almost twice as fast as actively managed ones between 2013 and 2018.

According to the annual survey, published this month, European institutional passive investments grew 14.6% a year during the period, while actively managed assets increased 7.8% annually. Globally, passive assets gained almost 18% a year between 2014 and 2018, while active pools grew by 9.2%.

As we travel the ninth year of the current bull market, the question is whether passive strategies will continue on this trajectory and what factors and markets will drive flows.   

Leap in ETF assets in recent years

The passive investing revolution is intrinsically linked to the expanding menu of index-based products such as exchange-traded funds (ETFs) that offer easy and cost-efficient access to a growing number of strategies and asset classes.

The growth figures reflected in the IPE survey are the result of net inflows combined with asset capitalization; they suggest that gains from inflows have benefited passive portfolios more than active ones. For comparison purposes, the STOXX® Europe 600 Index posted compound annual growth of 9.8% between 2013 and 2018.2 The STOXX® Global 1800 Index grew 13.8% a year in euro terms over that period. However, passive mandates in the IPE survey cover all asset classes.

In a recent European ETF survey3 covered on PULSE ONLINE, around 40% of poll participants currently investing in equity ETFs said they plan to boost ETF allocations in that asset class in the next 12 months.

A tailwind from rising markets

ETFs may also have benefited from cyclical factors. Some observers have noted that ETFs get a boost from bull markets. As all stocks gain, they argue, it makes less sense to pay for a manager’s view that may be blindsided by a rising tide.

Luke Oliver, head of US ETF Capital Markets at Deutsche Asset Management, wrote in April that nine years of a bull market with low volatility have been “a perfect scenario for passive strategies.”4

Will passive start lagging when the tide turns? Not necessarily. The ageing of this bull market coincides with the current boom in smart-beta ETFs that exploit factors such as value, and in funds that hedge against systemic risks. These hybrids between active and passive strategies provide investors rules-based vehicles to navigate falling markets and rising volatility.

Some of these systematic approaches include risk-control, market-neutral factor and minimum variance strategies, to name some.

More and more, professional asset managers are combining active with passive offerings in response to client demand. As a higher number of institutional and retail investors turn to passive funds for a broader range of asset classes, these flows will continue to be a defining feature in the transformation of the asset-management industry.

Passive growth in fixed income poised to catch up

Equities is where active funds are struggling the most with flows. According to Morningstar,5 US investors withdrew $175 billion in 2017 from actively-managed equity funds, while they poured $470 billion into passively-managed vehicles. In Europe, flows into passive equity funds were more than three times larger than those into active funds.

In other categories, including fixed income, flows into active vehicles beat investments into passive products.

Historically, slow traction behind fixed-income ETFs was blamed on the idiosyncrasies of the bond market, in particular its over-the-counter nature and the lack of liquidity in some segments. Price discovery shortfalls made it challenging to determine index levels and fostered the idea that an active manager’s skill and information provided an advantage.

Interestingly, however, the same market depth limitation has been more recently cited as a driver for flows into bond ETFs.6 The vehicles provided much-needed tradability and price transparency over episodes of market stress during and after the global financial crisis. At the worst of those moments, it was bond ETFs that offered indicative pricing in the market, rather than the other way around. Something similar happens frequently after trading hours.

In the European ETF survey, 65% of respondents said they use ETFs for fixed-income exposure. That is up from 48% who said so a year earlier. One in four current ETF users plans to add to their fixed-income ETF holdings in the next year, compared with one in 10 who said they were likely to decrease their usage.

There are also structural drivers of ETFs’ growth, including technology and regulation. But those are topics for another post.

1 IPE, Top 400 Asset Managers survey, June 2018.
Total return after taxes.
3 Greenwich Associates, ‘European Institutions Explore New Asset Classes with ETFs,’ May 2018.
4 DWS, ‘ETF Flows: Hyperbolic, not parabolic,’ Apr. 5, 2018.
5 Morningstar, ‘2017 Global Asset Flows Report,’ May 16, 2018.
6  Greenwich Associates, ‘Institutional Investors Embrace Bond ETFs,’ Sep. 21, 2016.