The popularity of passive investments, such as ETFs and index funds, are on course to achieve a leading share of the US market by 2024, or sooner, according to Moody’s latest Investors Service report.
Using linear regression and diffusion assumption models, Moody’s predicts passive investing to overtake active in the US between 2021 and 2024.
Passive investments currently account for $6tn of assets globally and, in the US, account for over 28.5% of total assets under management (AUM), a figure poised to exceed 50% in the next four to seven years if current growth rates are maintained.
“We believe that the passive phenomena is more appropriately viewed as the adoption of a new technology,” said Stephen Tu, Moody’s Vice President and Senior Analyst. “Investor adoption of passive and low-cost investment products will continue irrespective of market environments, and we estimate that passive investments will overtake active market share by sometime between 2021 and 2024.”
The report reached its conclusions using two approaches: a linear regression of market share versus time, and by fitting recent passive fund AUM data to a diffusion model which projects near-term market share.
The linear regression model predicts passive to overtake active in seven years, or 2024. Moody’s believes this future passive investment adoption rate is very conservative, since its lookback period, 1996 — 2016 falls during a time when passive investing was viewed with greater scepticism.
Its second approach uses a diffusion assumption model which melds well with market share data since the financial crisis and indicates a period of four to six years for passive funds to reach 50% market share relative to active.
Driving the continued growth of interest in passive funds, Moody’s perceives smart beta and multifactor funds will be the next hotspot for investor dollars owing to potential expected return profiles and cost advantages. Additionally, Moody’s believes digital investment managers or “robo-advisors” are on the cusp of gaining significant traction as financial and investment technology improves, further spurring the growth of passive investing.
Such changes are likely to put further pressure on active management to continue revising downwards the fees charged to clients.
While passive investing has experienced a surge in growth in the US, the rest of the world has seen a smaller penetration, approximately 5%-15%. Moody’s points to less awareness of passive products or sales practices which do not favour the best interests of investors as reasons for this digression.
That being said, Moody’s believes the potential for overseas growth in passive investing remains robust as markets mature and investors become more aware of the products.
“Over time, we expect passive adoption in the EU and Asia to follow a pattern similar to the US, provided that global transparency and communication improves and that global financial markets continue to mature and become more investor-friendly,” said Tu.