Fitch: Valuations Offset US Active Manager Pressures, For Now

NEW YORK--()--Near-record US equity market valuations are offsetting the potentially negative credit effects that US active fund managers face from the erosion of their market share and management fees related to the rise of indexing and passive investment strategies, says Fitch Ratings. Strong equity markets limit the financial impact on rated traditional investment managers, at least for the time being.

Investors' growing acceptance of indexing and other low-cost, passive investment strategies have aided passive-focused managers' growth and elevated their importance in the credit dynamics of the investment management landscape, in our view. Active investment managers' market share erosion to passive strategies, while not a new trend, continues to pressure active fund managers' due to a mix of investors' fee sensitivities and the proliferation of exchange traded funds, many of which are also marketed as lower cost and index based. If and when an equity market correction occurs, underperforming active fund managers would feel the triple effects of shrinking assets under management (AUM), declining market share and lower fees on AUM.

The growth rate of AUM invested in passive strategies has accelerated past the growth of AUM in active strategies among US-registered funds by an average over 10% per year, over the past four years, a wider margin than seen prior to the financial crisis, based on data from the Investment Company Institute (ICI). Net inflows to US index mutual funds and index-based ETFs were $148 billion in 2014, up from $114 billion in 2013 -- both record years. Active strategies meanwhile continue to suffer outflows. Cumulatively, the outflows from active strategies have nearly matched the cumulative inflows into passive strategies over the past 15 years.

In spite of passive strategies' rising market share, represented in the chart https://www.fitchratings.com/web_content/images/fw/fw-chart-20150601.htm, active fund managers still retain a strong majority (nearly 80%) of the overall US equity fund market and generally still earn higher fees. Equity-focused active asset management strategies reached a record $6.6 trillion in AUM, as of year-end 2014, while equity indexing and indexing-based ETFs reached nearly $1.7 trillion. The sheer size of the active investing market still leaves significant market opportunities for individual active managers to perform better than overall trend averages. Yet the direction of the market share graph leaves little doubt that the markets' acceptance of passive strategies remains strong. In fact, over the past two years, the trend toward indexing and indexing-based ETFs appears to be accelerating.

The largest indexing and passively focused managers such as Vanguard, BlackRock, State Street Global Advisors, Invesco Ltd. and Dimensional Fund Advisors have benefited the most from the continuing secular trend toward passive investing. Collectively, these firms hold an overwhelming majority of the indexing/passive US market. Their size and scale makes it very challenging for competitors to win share and earn solid profits. Bond and hybrid (or mixed asset) indexing funds and ETFs comprised about $373 billion of AUM as of year-end 2014, bringing the total US-registered market for index-based products to $2.05 trillion, up from $1.73 trillion at the end of 2013, based on the ICI's classifications.

Fee pressure also continues to impact active traditional investment managers, largely due to competition from passively managed strategies' significantly lower fees. Asset-weighted expense ratios of all US equity funds dropped another 4 bps over 2014 to 70 bps according to ICI. Over the past five years, overall equity expense ratios on an asset-weighted basis are down about 20%, from 87 bps at the end of 2009, according to ICI.

In spite of the declining fee trends and active management's loss of market share, Fitch maintains a stable rating and industry outlook on the investment management sector. This reflects investment managers' increasingly diversified AUM (by product and strategy), strong margins and modest leverage, among other factors. Individual ratings could be pressured if the shift toward passive investing results in more material AUM outflows, reduced fees/margins or increased cash flow leverage. One possible response for active managers would be to slow AUM inflows, as outperformance may be more achievable with less investible assets to deploy.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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Contacts

Fitch Ratings
Nathan Flanders
Managing Director
Financial Institutions
+1 212 908-1827
or
Tyra Junaid
Director
Financial Institutions
+1 212 908-0291
or
Matthew Noll, CFA
Senior Director
Financial Institutions Fitch Wire
+1 212 908-0652
or
Media Relations:
Alyssa Castelli, +1-212-908-0540
alyssa.castelli@fitchratings.com
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Nathan Flanders
Managing Director
Financial Institutions
+1 212 908-1827
or
Tyra Junaid
Director
Financial Institutions
+1 212 908-0291
or
Matthew Noll, CFA
Senior Director
Financial Institutions Fitch Wire
+1 212 908-0652
or
Media Relations:
Alyssa Castelli, +1-212-908-0540
alyssa.castelli@fitchratings.com
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com