by Patrick Gallagher

January 13, 2017

Will 2017 be the year “the empire strikes back” in the war between active management and passive investing?

Passive funds won the asset share battle again in 2016, as investors pulled a net $358.8 billion out of U.S.-based actively managed mutual funds in the 12 months to the end of November 2016, while pouring $479.8 billion into passive funds, according to Morningstar. Over the last three years, investors have moved more than $1 trillion into index funds.

The money has followed index funds’ razor-thin fees and years of outperformance. But that advantage is not a given. “Both investment philosophies have enjoyed multiple and sustained periods of outperformance over the past 30 years,” notes Daniel Farren, a Boston Partners senior portfolio analyst, among others, and the market may be at a turning point.

Active managers tend to underperform when stocks move slowly upward in tandem, as they generally have since early 2009, explains Wall Street Journal columnist Steven Russolillo. “Episodes of volatility,” such as Brexit and the U.S. election, “have created conditions that are favorable to stock pickers for the first time in years.”

True to form, during the second half of 2016, 60 percent of actively managed funds were beating the Standard & Poor’s 500 index, the highest level in nearly two decades.

So, if we are truly at the beginning of an extended period of outperformance for active managers, will it be enough to turn the funds flow back in their direction?

Probably to an extent with institutional investors. In a recent global survey of 500 firms by Natixis Global Asset Management, 73 percent said the current market environment “is likely favorable to active management.” Over the longer term, “…Institutions project they will use less passive investments than they previously believed.”

But with individual investors and their advisors, the die seems cast. As the Wall Street Journal summarized, “Government mandates, lawsuits and an ever-more available slew of mounting data are leading managers to turn to passive investing as the lower-cost, default options for more Americans each year.”

The Trump rally may continue to deliver outsized returns for actively managed funds, and the President-elect may repeal the government-mandated “fiduciary rule.” But even this combination isn’t going to halt the trend toward passive investing, writes MarketWatch reporter Ryan Vlastelica.

As for a sustained bear market, that seems more likely to prompt investors to abandon stocks altogether rather than move their money to actively managed funds.

As Morningstar commentator and former managing director Don Phillips observed shortly before the election, “The U.S. stock market is up 175% over the past seven years, and yet there’s virtually no (public) enthusiasm for investing.”

That is another long-term trend unlikely to be reversed over the next four years.

Has the trend toward passive investing had an impact on your stock price performance and shareholder mix?