Passive Mutual Fund Assets to Surpass Active in ’24

Passive investment assets in mutual funds and exchange-traded funds will surpass active ones by early 2024, according to research released Tuesday by Cerulli Associates.

The shift is a symbolic achievement for passive investment strategy—which saves on fees—versus active management investing that once dominated. But, Cerulli notes, active strategies are still strong, holding overall market share when including other types of investment vehicles, such as separately managed accounts and alternative investing structures.

Meanwhile, when considering target-date funds and collective investment trusts for defined contribution retirement plans, passive investing strategies already outpace passive investments, according to separate analysis by researchers.

Passive vs. Active

Cerulli noted in its research that passive mutual funds and ETFs were just one-quarter of the market about a decade ago, but they are now poised to overtake active strategies in the first quarter of next year.

“Since then, passive assets in the two vehicles have stolen one to three percentage points of market share from actively managed assets each year, reaching 49% of market share as of the end of 2Q 2023,” according to the report.

The trend has occurred even amid the economic uncertainty and market dives of recent years, when asset managers have often considered active strategies to be more popular, according to Cerulli, noting that “conflicting patterns have been seen during the beginning of the current decade.”

Active investing, however, is still dominant when pulling the lens back for a wider look. When Cerulli added collective investment trusts, money markets, retail SMAs and alternative structures into the mix, active strategies jumped to 70% market share, compared with passive, as of the end of 2022.

“The growth of money market funds, alternative assets, and separate accounts has grabbed some of the market share fleeing from actively managed pooled products, making the fate of actively managed mutual funds look not quite so dire,” researchers wrote in an executive summary of the report.

The trend toward other types of investment vehicles—as opposed to pooled options such as mutual funds—may slow the shift toward passive, according to the researchers.

“Time will tell where the critical point exists upon which passive investing becomes a risk, where the mechanism of blindly buying securities based on their prices rather than their cash flow could blow back,” Matt Apkarian, associate director at Cerulli and lead author of the report, said in a statement.

Macro factors will also play a role, the consultancy noted. Geopolitical shock (73%) and recession (69%) were at the top of the list for scenarios that may drive more demand for active investment management that can seek to work around market drops. 

Passive Rules CITs

The dance between passive and active strategies in CITs has already been won, according to separate analysis from Simfund, which, like PLANADVISER, is owned by ISS STOXX.

Passive investments make up 56.7% of the $3.2 trillion in assets held in CITs for as of June 2023, according to data run by Alan Hess, ISS STOXX’s vice president for U.S. fund research, up from 54.2% of the $2.9 trillion CIT market at the end of 2022.

“Cost advantages have been a key driver of increasing market share for CITs, as their lower registration costs and the ability for trust providers and plan sponsors to negotiate on cost have allowed them to offer lower relative fees,” Hess says via email.

Part of the passive dominance comes from a relatively small market of providers, Hess notes, with the top five players managing 97.1% of assets and the Vanguard Group, which follows a passive, low-fee strategy, holding 54% of CIT target-date fund assets, as of the second quarter of 2023.

Active investments, however, “can still have a solid place within the defined contribution market,” Hess notes, as once professionally managed products are put into DC plans, they tend to stay with investors who have a “set-it-and-forget-it” mentality. The risk to their continued use, for the most part, comes from the close scrutiny fees get among retirement advisers and plan sponsors.

“The compounding effects of cost over time and the litigious nature of many parts of the retirement market mean that costs are going to continue as an important and closely-watched factor across vehicles,” Hess says.

CIT provider Great Gray Trust Co. noted that active strategies are still a part of the investment structures. 

“We see active management flows across all core line-up categories on our platform,” president and CEO Rob Barnett says via emailed response. “Data shows participants need alpha in their investments in order to reach their retirement goals.”

TDFs, Too

In research looking purely at TDFs—whether in CITs or mutual funds—passive solutions “dominate” assets under management, according to an emailed response from Chris Brown, founder and principal of Sway Research.

At the end of 2022, 60% of $2.8 trillion invested in non-custom TDFs were held in passive underlying portfolios, an increase from 53% at the end of 2018, which Brown attributes to multiple reasons.

“CITs are largely used to lower costs over MFs, and a CIT-based TDF with passive underlying investments is about as low cost as you can get,” Brown says. “Thus, CITs and passive TDFs are like peanut butter and jelly.”

Additionally, passive management giants such as BlackRock, Fidelity Investments, State Street Global Advisors and Vanguard have all been major players in the DCIO space.

“Passive management is a scale game,” Brown says. “Firms with higher assets can afford to lower expenses more and are thus more competitive. So, as passive management expands asset share, expenses are forced down, profit margins shrink for those struggling to keep up, and smaller competitors are forced out.”

As Cerulli’s report also noted, Brown says, “active managers are looking for categories outside of TDFs where they can effectively compete.”