One month ago we pointed out that the pain for active money managers is fast approaching unbearable status when according to a recent BofA analysis, the outflows from active funds in 2016 have surpassed a record $200 billion, with the bulk of cash outflows shifting over to much cheaper (and better performing) passive funds, though as BofA notes, flows have slowed since last year suggesting that there may be a broader cash outflow from the equity asset class, as increasingly more Americans retire and pull out of the market entirely.
We have covered the underlying dynamics behind this shift for years, which mostly involves activist central bankers, lack of market volatility, underperformance of short books, high fees charged by active managers and generally an inability to generate significant alpha by the active investment community.
And unfortunately for the active managers of the world, the latest fund flow data from ICI shows no signs that the pain will relent any time soon. As Reuters reported today, U.S.-based stock mutual funds reported the largest outflows in five years, based on ICI data. $16.9 billion was pulled from stock mutual funds in the seven days through Oct. 19, more than in any other week since August 2011.
While most of the money was withdrawn permanently, some of the funds were reallocated, as has been the frequent case in the past 5 years, to passive strategies: stock exchange-traded funds took in $2.4 billion. And why not: with ETFs charging a fraction of what active managers demand, and closely hugging market indices which for the 7th year in a row will outperform the vast majority of hedge funds, this seems like the sensible thing to do, even if it means that many hedge and mutual fund managers will soon be out of a job.
"The trend to passive ETFs has persisted throughout the year," said Todd Rosenbluth, director of ETF and mutual fund research at CFRA. "Active funds have failed to keep up with common benchmarks this year, and investors are looking for lower-cost alternatives."
The outflows from stock mutual funds come ahead of the Nov. 8 U.S. presidential election and a potential interest-rate hike by the Federal Reserve that could push equities lower.
"Investors sharply rotated out of large- and mid-cap mutual funds last week, just as the start of earnings season kicked off," said Rosenbluth.
Meanwhile, while the broader active universe had a bad week, the more focused hedge fund world had an even worse month and an absolutely abysmal quarter. According to eVestment, hedge funds suffered $10 billion in outflows in September, while in the third-quarter investors pulled $29.2 billion from the hedge funds industry, which has clearly lost its allure and mystique to would be investors, who are now far more interested in getting their money out, rather than in. This would be the largest quarterly outflow from hedge funds since the first quarter of 2009.
For all of 2016, outflows have grown to a total of $60 billion and rising.
The good news is that the hedge fund industry still manages roughly $3 trillion at end of September. The bad news is that the outflows are soaring at a time when the S&P is trading at all time highs which means that "it is only downhill from here." The even worse news is that as we reported last week, hedge fund compensation is set for a "massive" pay cut, with portfolio managers expecting a 34% reduction in their compensation this year.
But perhaps the best news is that as the following chart from Bloomberg shows, it has now become virtually impossible to launch a hedge fun, with only those with an immaculate track record or existing rainmakers able to obtain the seed capital needed to do their own thing.
This means that a generation of some of the brightest young men and women will have no choice but to seek jobs that contribute at least marginally to society, even if it means collecting far lower pay.