By Patturaja Murugaboopathy
(Reuters) – Global passive equity funds’ net assets surpassed those of their active counterparts for the first time in 2023 as investors increasingly sought lower-cost funds that mirror broad market indices.
According to LSEG Lipper, global passive equity funds’ net assets stood at a record $15.1 trillion at the end of December while those of active funds was $14.3 trillion.
Passive funds, often associated with stable, large-cap stocks with strong fundamentals and lower volatility, have grown in popularity since the 2008 financial crisis as investors sought safety in periods of uncertainty.
John Cunnison, chief investment officer at Baker Boyer said large U.S. companies have led global market performance across time frames ranging from 3 years to 10 years, significantly lifting market cap-weighted passive index funds.
“When these companies have extraordinarily strong performance, the performance of the indices is better than just about any other method of portfolio construction.”
The SPDR S&P 500 ETF Trust led passive fund inflows in 2023, netting a substantial $52.83 billion. It was closely followed by the iShares Core S&P 500 ETF and Fidelity 500 Index Fund, which attracted a net $38.1 billion and $24.79 billion, respectively.
Active funds faced consistent outflows, a situation worsened by their higher management fees and underwhelming returns. According to Lipper data, last year saw active funds suffer outflows totalling $576 billion, in stark contrast to passive funds, which attracted inflows of $466 billion.
Analysts say this influx into passive funds could spawn market imbalances, with large-cap stocks ascending regardless of their actual growth potential.
Geoffrey Strotman, senior vice president at Segal Marco Advisors, said higher inflows into passive funds can create or exacerbate pricing discrepancies and lead to a less efficient market.
“This inefficiency should create more opportunity for active managers to purchase stocks at attractive pricing and sell stocks when they are too expensive.”
Mark Haefele, chief investment officer of wealth management at UBS AG, expects active funds to experience a resurgence this year, with likely Federal Reserve rate cuts expected to reduce borrowing costs and boost earnings more significantly for small-cap companies than their larger counterparts.
“There can be bigger payoffs to stock selection in smaller-cap indexes compared to large caps, due to a higher dispersion in performance. Since most companies are less followed by the analyst community, there can be greater inefficiencies that can be exploited,” he said.
“As a result, there is greater scope for active managers to achieve above-market returns (alpha) in this part of the equity market.”
(Reporting By Patturaja Murugaboopathy; Additional Reporting by Gaurav Dogra in Bengaluru; Editing by Vidya Ranganathan, Kirsten Donovan)
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