Passive Stock Fund Investments Surpass Active Strategies for the First Time | ETF Trends

As the popularity of exchange traded funds continues to rise, passively managed index fund strategies have now overtaken actively managed funds’ dominance of the U.S. equity market for the first time.

According to Investment Company Institute data, passive funds made up 16% of the U.S. stock market capitalization as of the end of 2021, compared to the 14% for active mutual funds, the Financial Times reported.

In comparison, active funds held 20% of U.S. stock market capitalization back in 2012, compared to the 8% for passive funds.

Investor habits have shifted over the past decade with a steady cumulative net flow of more than $2 trillion bleeding out from actively managed domestic equity funds into passive fund strategies, notably toward cheap, efficient, index-based ETFs. Many have grown disillusioned with the underperformance among actively managed fund strategies on top of the higher management fees associated with the investments.

“It’s the latest milestone to fall [to index funds]. It’s been a slow build for decades now,” Kenneth Lamont, senior fund analyst for passive strategies at Morningstar, told Financial Times. “It does raise questions of what the endgame is. Passive is only efficient as the active players in the market make it. We probably have some way to go before passive becomes less efficient, but it does raise questions as to where the equilibrium should be.”

Actively managed domestic equity mutual funds have suffered through net outflows every year since 2005, whereas their passive peers have attracted inflows for every year, except 2020 and 2021.

Additionally, index-based ETFs have quickly become a go-to choice among many investors. U.S.-listed ETFs, many of which passively track an index, have seen assets surge fivefold to $7.2 trillion since 2012. The surge in interest was particularly noticeable last year after the net issuance of ETF shares, which includes reinvested dividends alongside net buying, almost doubled to $935 billion compared to the $501 billion in 2020.

The current market environment may continue to favor the passive index-based style.

“If anything, every sell-off accelerates the rotation to passive. Investors sell actively managed funds first, while ETFs and index funds benefit from the mechanic demand of target-date funds,” Vincent Deluard, global macro strategist at StoneX, told FT. “By default, all American savings are now invested in TDFs and rolled over into index funds.”

“I expect the unfolding bear market will be very serious and will feature outflows from ETFs and index funds, but it will be much worse for the active sector. When the passive sector sneezes, the active sector has pneumonia,” Deluard added.

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