Who's Really Benefiting from Active Management Outflows?
Source: FA-IQ, Feb. 1, 2017
Bruce Love, Managing Editor, FA-IQ
“Hi, this is Bruce Love with Financial Advisor IQ, and I’m here with Tim Baker, head of product strategy at Symmetry.
“Tim, you’ve been looking at the flows from active to passive last year and you’ve got a different take on it. What were your thoughts?”
Tim Baker, Director of Product Strategy, Symmetry Partners
"Yes, so if you look at 2016, everybody’s talking about all the money that’s going to ETFs and it’s fairly undeniable. So if you look at 2016, $288 billion went into ETFs last year. And, obviously, that has to come from somewhere, so $90 billion came out of active mutual funds.
“So that’s interesting, right? Because people are choosing this new vehicle and it’s driving a lot of innovation in the industry which we can probably talk about a little bit later, but the more interesting dialogue to me is where money is going from a philosophy standpoint. So ETFs and mutual funds are just vehicles for something else. You can do passive in a mutual fund. You can do active in an ETF. So what’s more interesting to me is that, if you look at 2016, you actually had $300 billion come out of all active — meaning all active mutual funds and ETFs. And then you had $500 billion go into all passive. So all passive mutual funds and ETFs.
“There’s a huge misunderstanding about mutual funds. ’Money’s leaving mutual funds’ — no. If you look at passive index mutual funds, there are enormous flows going into those vehicles.
“So, to me, I think that’s the more interesting conversation is, that’s an $800 billion swing, that $300 billion out of active and $500 billion into passive. And then the other interesting piece is, everybody would go, well, $90 billion out of mutual funds, that doesn’t sound like a lot to me. Well, there are places where money is going, like multi-asset and fixed income; really where people are voting with their feet is in active equity.
“And so what you saw last year was about $248 billion come out of active equity mutual funds. That was the single biggest source of outflow. Single biggest source of inflow: passive equity ETF. Active equity mutual fund going right across the hall to passive equity ETF. I can do this cheaper. If this manager’s not going to beat what this passive thing does, I’m leaving. I’m not going to pay them 80, 90, 100 basis points when I can own this thing for 10, 15, 20 basis points. Then, if you look at passive equity mutual funds, it basically made up the difference. So, basically, everything that left active equity mutual funds just went into passive equity, whether it was a mutual fund or an ETF.
“So it can get complicated, but I think it’s a more interesting piece of the puzzle than just looking at how much left mutual funds and ETFs. First of all, the story’s getting a little bit old. Everybody talks about it. But it just talks about vehicles. It doesn’t talk about philosophically why people would leave active and go to passive.”
"So you’re saying it’s more than just the cost play. It’s more than just ‘I can get this done cheaper.’ What are the philosophical arguments?”
"I’ve said this over and over again and I know I’m not necessarily unique here, but nobody cares what the cost of a mutual fund is if that manager is outperforming their benchmark. So, if you look back through history, you have this narrative that—and, in one of my former roles, we basically took a look at the large cap value space, because we had a large cap value fund that we wanted to get more attention for and it had really good performance and it wasn’t expensive. So we went and did an evaluation of the large cap value space because everybody says, well, money’s leaving active equity mutual funds. And, at the time, it was true, you had about $23 billion in annual flows coming out of large cap value.
“But if you turned that on its head and said, well, let’s look at all of the managers and let’s look at gross and net flows, particularly in the independent channel, you actually had a lot of gross inflows into the large cap value space. And you had about five managers that were getting about 50% of all of that inflow. They had great performance. They were in the top quartile. And they had low fees. If you have great performance and you’re not massively expensive—I mean, the range on mutual funds is, on an active mutual fund you could run as low as 22, 30, 40 basis points, on up to 150, 160, 180, 200 basis points.
“So I think that the issue there is not so much that, well, ’I just hate active management.’ The philosophy is ’I hate active management if it’s going to charge me a lot of money and not do better than the thing that I could buy for much cheaper.’
“So I think that’s the more important component, is everybody just goes, well, nobody wants some mutual funds. And there’s big narrative around, well, ETFs are more cost-efficient, that’s why people are leaving mutual funds. Again, trust me, if you’re beating a benchmark and you’re doing it handily, by 100, 150, 200 basis points, people will complain about the tax bill more than they will about the expense ratio. But a lot of those things is, like, well, I’ll complain about it, but I really like this manager continuing to beat the benchmark.
“So I think a lot of those issues with cost go away with some performance.”
"Thank you very much, Tim.”
"Thank you. Appreciate it.”