Passively managed funds weathered the market volatility of 2020, highlighting the need for active funds to deliver better and more consistent performances in order to slow the erosion of their market share.

Amid the Covid-19 pandemic, global equity markets fell by more than 30% in March, sparking unprecedented volatility for index-tracking funds and passive investors. Both strategies posted net outflows for the month. But while actives lost 3% of starting-year assets under management ( AUM ), their passively managed counterparts lost only 1%, according to a global data provider.

“Although stock market declines early in 2020 tested passive strategies, the swift recovery in global equity markets meant there was little threat of an exodus to active vehicles,” says Fabrizio Zumbo, associate director, European asset and wealth management research, at Cerulli Associates, a global research and consultancy firm.  He expects passive funds to continue gaining market share in 2021.

Passive funds have been steadily growing net inflows in recent years. In response, instead of pitting active strategies against passive strategies in portfolio construction, the investment industry has shifted to more widely endorsing an approach that combines the two.

Nevertheless, passive products continue to gain ground, helped by a track record of outperformance and falling fees.

ESG investments

Zumbo expects the growing demand for environmental, social, and governance ( ESG ) investments to drive demand for both active and passive funds.

ESG mutual fund, index tracker, and exchange-traded fund ( ETF ) assets have all grown rapidly over the past five years, Cerulli says. From 2015 to 2019, actively managed mutual fund assets grew at a compound annual growth rate ( CAGR ) of 15%, index fund assets at  34%, and ETF assets at 72%.

Institutional investors have driven the growth of responsible investment assets in Europe. Since 2015, total institutional responsible investment assets, including those held in mutual funds and ETFs, have grown by 16.8% per year to more than 5 trillion euros ( US$6.7 trillion ), according to Cerulli’s estimates.

In the retail investment market, Europe-domiciled mutual funds and ETFs passed 1 trillion euros in ESG assets in August 2020.

More than half ( 57% ) of the ETF issuers in Europe that Cerulli surveyed identified the development of ESG ETF products as a top priority for their firms over the next two years. Several have launched innovative and highly specialized ESG value propositions.

Systematic approach

ESG investments have favoured active players and asset managers’ ESG integration approaches are evolving from simple exclusion ( screening to avoid sectors such as alcohol, tobacco, and weapons ) to a more systematic approach.

This presupposes a high level of active management – for example, incorporating ESG factors into investment decision-making and employing stewardship practices to ensure that all financially material factors are included when assessing risk and returns.

However, passives are increasingly gaining ground in this space. Passive ESG equity fund assets grew at a CAGR of 32% from 2015 to the end of 2019, while active ESG equity fund assets had a CAGR of 17% over the same period.

Some 73% of the ETF issuers that responded to Cerulli’s survey expect significant demand for ESG ETFs in Germany and 70% expect significant demand in Sweden and France.