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Following the herd into passive could end badly

Investors are bearish on active funds, but a switch to passive could be a bad decision
May 2, 2019

Investors have continued to take capital out of UK-domiciled open-ended investment funds in 2019, despite a relatively calm period for markets and a delay to the UK’s exit from the European Union (EU) until October. Figures from data company Morningstar show that investors took out nearly £5bn from investment funds in March alone, and over the past 12 months they have withdrawn nearly £30bn.

This trend, which was also the case in most of 2018, comes at the same time as a change in market direction. Last year markets were incredibly volatile and most regional equity markets ended the year below where they were at the start, a reason why investors have been piling out of markets. MSCI All Country World index fell 4 per cent over 2018 due to a tricky start to the year, which became the foundation for bearish sentiment. Although this index rose nearly 10 per cent in the first three months of 2019, it has not changed investors' negative sentiment.

Equity funds overall experienced net outflows of £2.9bn in March, and the fund areas investors took most money out of included UK equity income, global equity income and European large-cap equity – three sectors that have been unpopular for some time. Economic forecasts for the UK and Europe remain poor.

Bhavik Parekh, analyst at Morningstar, said: “Bucking the trend of outflows this month have been money market funds. These are the lowest-risk funds that you can invest in and are usually only used for short-term periods. Given the uncertainty around Brexit, it is no surprise that investors have chosen to move assets into the lowest-risk funds.”

Money market funds enjoyed net inflows of over £500m during March. But Mr Parekh said more investors were buying equity funds focused on growth-driven regions.

Another popular area was global large-cap equity funds, which had net inflows of £634m during March. These mainly went into two passive funds, BlackRock ACS World ex UK Equity Tracker (GB00BD71XX07) and Vanguard FTSE Developed World ex UK Equity Index (GB00B59G4Q73). This suggests that although investors are bearish on the UK and active funds, they are still happy to have passive exposure to global equities.

However, a recent survey by Natixis Investment Managers of 200 professional fund buyers and analysts found that they have a growing preference for actively managed funds and they do not plan to change their asset allocation much in 2019, sticking with risk assets such as equities. Two-thirds of those surveyed said volatile markets in 2018 have made them more likely to use active funds.

Matthew Shafer, head of global wholesale at Natixis Investment Managers, said: “A large proportion of global fund buyers agree that actively managed investments outperform passive portfolios in the long run, with 72 per cent of their portfolio investments being actively managed, a share they expect to remain relatively constant over the next three years.”

The Investment Association, the trade body which represents UK investment managers, has also published figures showing that active funds experienced net outflows over the past six months but passive funds experienced inflows. Active managers can struggle when equity markets reach latter stages of the market cycle such as now, so investors often move into passive funds in the hope of better returns. However, such a move can often end badly during bear markets when active funds tend to outperform.

 

Asset flows

AssetMarch 2019 net flows (£m)12-month net flows (£m)
Cash5551,667
Bonds337893
Other94-12
Property-330-2,135
Multi-asset-575-2,453
Alternative assets-1,720-14,001
Equities-2,896-11,790

Source: Morningstar as at 31/03/2019