Traditional Manager ETF Focus May Be Too Little, Too Late

In an attempt to jump on the exchange traded fund bandwagon as investors turn to more passive investment products, traditional asset managers have also tiptoed into the ETF space, but the shift may not be enough to stopper outflows from their businesses.

According to a recent note from analysts led by Stephen Tu at Moody’s Investor Service, passive investing will remain popular, the acquisitions of ETF companies are not long-term solutions for fund companies and the pool of active managers will likely shrink to weed out poor performers, reports Chris Dieterich for Barron’s.

Actively managed mutual funds have been experiencing greater outflows as investors look to cheap and easy-to-use passive index-based ETFs.

In light of the rising popularity of ETFs, a number of mutual fund companies have turned to the investment vehicle as a means to attract investors, launching a number of smart-beta ETFs that implement actively managed strategies in a passive wrapper.

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Additionally, some fund companies have responded to the rising popularity of ETFs by outright acquiring ETF companies to gain a foothold in the industry.

However, analysts at Moody’s argue that the mutual fund industry’s efforts to put a foot through the door into the ETF world are not enough.

“A number of active managers that had not previously offered passive products have recently altered their strategies, and either made acquisitions or created new products to address the shift from active to passive investing,” according to Moody’s. “Much of this investment has been in ETFs and smart beta, which are likely to take share from traditional active management. M&A has also taken the form of active managers buying other active managers, both traditional and alternative. These managers view M&A as a strategy to address the passive trend. However, although there may be cost synergies, in most cases, this type of M&A is not a long-term solution since it does not reduce the amount of capital managed by active managers, so overcapacity continues to hamper performance.”

Related: ETFs Gain Ground as Advisors Look to Passive Beta-Index Strategies

Even if mutual funds step in and aggressively expand with ETF offerings, the increased M&A activity does not address the underlying issue that many actively managed fund products still have unattractive track records.

“A handful of managers, such as AllianceBernstein, have acknowledged that overcapacity is an issue the industry will have to address,” Moody’s said. “Over time, active management will likely have to shrink substantially.”

Related: Active Managers Losing Ground to Passive Index Funds, ETFs

Looking ahead, the emergence of smart-beta ETFs, which combine actively managed styles in a cheap and passive index-based wrapper, could also eat away at active manager’s market share. However, Moody’s warned that investors may favor a handful of outperforming strategies, which could give rise to a high concentration of assets among a few smart-beta options, reflecting what could occur in the actively managed mutual fund space.

“Given the scalable nature of quantitative investing, the large number of smart beta managers is also likely to shrink to a few surviving winners managing large amounts of capital,” Moody’s added.

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