Requiem For A 2-And-20 Dream: In August 2022, Passive Funds Will Surpass Active

It's tough being an active manager - i.e., an actual human in the world of equity investing - these days: not a week seems to go by without investors pulling money out of actively managed funds and redepositing it into much better performing, and vastly cheaper passive funds, and this week was no exception.  According to EPFR, this week saw another $1.3 billion in ETF inflows while mutual funds saw another $8.3 billion redeemed for a total of $7.1 billion in equity outflows (not even the US was spared with $4.4BN in outflows), a relentless trend observed since the Q4 2018 crash, and still a paradox in light of the broader S&P melt up.

And, as BofA's Michael Hartnett notes, a simple extrapolation of recent trends suggests that the sun is setting not only for the "2 and 20" hedge fund crowd, but virtually every aspect of active management: the past 10 years have seen a record $2.3 trillion allocated to passive equity, while $2.6 trillion flowed out of active equity. This means that a historic inversion is expected to take place in August 2022, or in just over three years time - that's when the AUM of passive equity funds will surpass active equity.

Whether August 2022 is the precise moment when passive surpasses active is debatable, but the trend is clear: as investors continue to pull cash out of equities, they reallocate modestly to passive strategies, while shifting the bulk of their holdings to yield and other fixed income strategist. Indeed, in the past 10 years, some $2.3 trillion has flowed into bonds, and a measly $0.3 trillion into stocks. 

Some good news for all those equity managers who are reading the writing on the wall: before an algo or robot takes your job, you may still have a future in the business if you shift from equity to debt; to wit, there have been record bond fund inflows in 2019...

... coinciding with record high bond prices, and central banks once again pushing the narrative of zero/negative rates everywhere.

The transformation of the financial services industry from a human to a robot-led one aside, the question of how stocks can keep rising in the face of these massive outflows from stocks (and to bonds), once again emerges, although as BofA's CIO Michael Hartnett writes, the puzzle of record equity prices and sustained equity outflows is solved by

  1. US corporate Great Rotation...since 2013 US corporate debt issuance = $10.5tn, stock buybacks = $4.2tn (on pace for record $823bn in 2019);
  2. number of listed US stocks down from 8090 to 4397 past two decades, in sharp contrast to Europe, China & RoW.

And here an interesting observation - if not so much for the human readers out there, who should be considering career outside of finance, as for the robots - while US equities are at all-time highs, the MSCI World ex-US index is still 13% below all-time high, which was hit in 2007. And here, a striking observation from BofA: "If the S&P500 had simply risen in line with global equities since 2009 low it would today be 1433 not above 3000."