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Active U.S. asset-management firms suffered record outflows in 2018 as a result of the persistent shift toward passive investment vehicles, suggests a new report from Moody’s Investors Service Inc.

Long-term mutual funds recorded US$369 billion in outflows last year, with most of this occurring in actively managed funds, the credit-rating agency states in the report. The outflow total in 2018 surpassed the previous record from 2008, when the global financial crisis sparked dramatic investor selling, but as a percentage of assets, 2018’s outflows were in line with 2008. Moreover, the Moody’s report notes that less than half of these outflows, US$174 billion, were recaptured by money market funds.

At the same time, Moody’s reports that inflows into ETFs remained robust during the year. In fact, the report states that “when markets declined and volatility increased in February 2018 and October-December 2018, net inflows into active funds did not materialize, while flows into passive products, notably ETFs, remained in line with the robust pace of recent years.”

The report argues that passive funds effectively represent superior technology for retail investors, supplanting active management. Moody’s says that passive funds continued to attract fund flows primarily because “passive products represent a more efficient vehicle for investors.”

Moody’s likens the shift to passive products to the adoption of new technology, such as consumers giving up landlines in favour of cell phones, a trend that will “steadily diffuse throughout the marketplace over time,” it says.

“Passive, low-cost funds are a more efficient vehicle to channel the earnings from corporate America to the end retail investor because there is less leakage of earnings from investment management fees to asset managers, trading costs to brokerages and other intermediaries, and investment activity and errors on the part of average active managers to the small number of truly superior active managers,” the report notes.

“The underlying driver of flows into low-fee passive funds over higher-fee active funds is changing consumer preferences as a result of greater transparency, rather than asset market trends, volatility regimes or macro factors such as quantitative easing or tightening,” the report adds.

Indeed, the argument that active management would regain favour with investors in more tumultuous markets is not being borne out.

Says Stephen Tu, vice-president at Moody’s: “The outflows from long-term mutual funds, which are predominantly actively managed, occurred despite increased volatility and favourable market conditions that provided active managers an opportunity to outperform passive investments—challenging a core tenet of active mutual fund distribution.”

The Moody’s report also says that this trend appears to be spreading beyond the highly liquid equities markets to other asset categories as well.

“Because of the zero-sum nature of active management, the greater efficiency of lower-cost passive funds applies to all public markets, regardless of liquidity, trading volumes or asset class,” the report says. “Flow dynamics in 2018 could be a sign that the passive technological trend is now also spreading into fixed income.”