While June inflows were the lowest since 2014, detractors still see danger for investors
The torrent of investor dollars going to passive funds has weakened, but it’s still too strong for some.
With the rise in volatility and the fall of the stock market earlier this year, new figures from Morningstar show 2018’s first-half net inflows into passive mutual funds and ETFs were weaker by 44% compared to flows over the same period last year. As reported in WealthManagement.com, the US$3.4 billion take in June was the smallest since early 2014.
Ben Johnson, director of Global ETF Research for Morningstar, said the deceleration is only natural after record highs seen in 2017. “Though the flows have slowed down compared to 2017, a few billion dollars inflows for 2018 is nothing to shake a stick at,” he said.
But one active-investing advocate sees something else at play. “Part of it reflects investor skepticism,” Jack Ablin, chief investment officer at Cresset Wealth Advisors, told WealthManagement.com. “They’re relatively bearish. There’s geopolitical uncertainty, headline risk and more volatility than investors are accustomed to seeing.”
Ablin warned that the continued abandonment of active strategies, which keep share prices fairly valued, will inevitably come to a head. “Active managers are the ones pushing the revolving door, while passive investors just stand there,” he said. “Eventually, if not enough people push the door, passive investors will be stuck in the middle.”
Rob Arnott, the founder of Research Affiliates who is widely viewed as the godfather of smart-beta investing, agreed. He argued that passive investment strategies tilt portfolios toward high-multiple stocks by chasing momentum. And while the past 12 years have seen growth stocks trounce value by 2.5% annually in terms of CAGR, he said value has historically won most of the time.
“The S&P 500 is essentially a momentum index now,” concurred retired hedge-fund manager Chris Litchfield. “People think this is a low-risk way to invest in markets. My view is that this is the single riskiest thing you can do.”
While index funds offer wide diversification and low costs, Litchfield maintained that passive investors are taking on more risk than they realize. He believes that while most people can’t afford to blindly hold sizable assets in such funds during a bear market, most do because of the promise of performance offered by index funds. And as demand for performance grows, Litchfield thinks that more fund managers will be lured into juicing their returns with leverage.
“This could ultimately make active management more attractive,” he said.
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