Thanks to tangled supply chains and COVID-19, the public inched toward a post-pandemic normal in 2021. Fund investors, though, pushed full steam ahead. In the U.S., long-term flows crossed the US$ 1 trillion mark for the first time, reaching $1.2 trillion by October. Assets under management (AUM) zoomed from $23.5 trillion to more than $27 trillion—a 17% gain for the year to date—putting 2021 on pace for the third consecutive year of double-digit asset growth.
ISS Market Intelligence’s 2022-2026 outlook for long-term funds, detailed in our State of the Market: Future of Retail Products Report, anticipates slower growth ahead. With stock and bond returns unlikely to match their recent gains, tomorrow’s growth engine will run with less gas in the tank. While we project long-term fund AUM to rise by an estimated $11.7 trillion, we anticipate average growth of just 7.4% annually.
What does this outlook mean for asset managers?
Do not expect markets to do the heavy lifting
Since 2019, two U.S. managers—Vanguard and BlackRock—have won 85 cents of every dollar in net new sales according to Simfund data. Many rivals have been starved for sales, with seven of the top 20 managers suffering outflows over the period. These firms were not necessarily starved for AUM growth, though, because markets rose sharply.
With weaker markets likely over the next half-decade, about 40% of expected AUM growth will come from flows. While potential trouble for managers with weak organic growth, those with the right product and distribution mix should not lack opportunity.
U.S. households remain flush with cash, and tight labour markets and higher income should keep the reservoir that helped fund 2021’s sales boom far from running dry. An estimated $5.4 trillion will flow into long-term funds over the next half-decade, about $2 trillion more than in the prior five-year period.
Look for positive-sum games
It is not crazy to think of the active/passive battle as a zero-sum game. If one gains market share, the other must lose it. Yes, it is better to gain share than to lose it, but how the pie is divided only tells part of the story; 25% of a small pie may be less valuable than 10% of a large one.
For example, active fixed income share will shrink modestly, but with the aging population pouring $3 trillion into bond funds, active managers will still end up with about $1.3 trillion of a fast-growing pie. Niche product categories like alternatives, which will see AUM growth accelerate as competition from passives remains muted, will offer similar dynamics on a much smaller scale.
By contrast, as equity fund ownership shrinks and passives control equity fund sales, the only way for active stock fund managers to get a larger slice of pie will be to take it from someone else.
Should active stock fund managers pack up their bags? Not necessarily. Slow-growing or declining markets may be an opportunity for managers with strong brands or distribution capabilities to consolidate their positions. Others can target areas where active managers can better compete, such as small caps or emerging markets. And with investors increasingly choosing multi-asset portfolios rather than individual funds, it could be hard to grow AUM in faster growing areas without offering capabilities in slower-growing ones as well.
Know your odds
By fusing an investment innovation (indexing) with an operational one (a tradable portfolio), ETFs undercut the mutual fund on cost, convenience, and tax efficiency. Over the next half-decade, innovations in technology and business models of online wealth platforms will fuel further gains, pushing total share from a quarter to a third of long-term assets by 2026. Active ETF assets will more than double over the period, albeit to a still-small 2.5% share of the assets.
No wonder fund managers have centred their product development efforts around ETFs. 2021 has seen a record number of ETF launches, with a majority actively managed and a plurality focused on U.S. equities. Few managers anticipate these funds will be instant hits, but most will expect them to reach sufficient scale to at least cover their costs within a few years.
The historical odds of getting there varies by asset class: About half or more of new taxable bond ETFs with 2016-2018 inception dates made it past the $100 million mark in three years, while less than a third of U.S. or international equity did. In alternatives and commodities, the odds of reaching sustainable scale were even lower.
Think software, not hardware
One major reason asset managers have bundled the “software” of investment ideas with “hardware” of the mutual fund or ETFs is because it has been both cost prohibitive and logistically daunting to invest in large numbers of securities directly.
Automated trading technology and the emergence of commission-free brokerage platforms increasingly will unbundle execution from the investment product, enabling a mass audience to customise their portfolios to their specific needs. The unbundling of the investment fund will increasingly leave managers selling their investment capabilities alone, almost as if Pfizer or Moderna marketed not their COVID vaccines, but just the formulas needed to make them.
Of course, these drug makers do not outsource manufacturing because making RNA vaccines is complex. Similarly, because many investment strategies will remain too complicated to execute at the investor level, investment funds will be with us for years to come. Still, mass customised portfolios will force managers to see themselves less as product manufacturers and more as licensers of their intellectual capital, much like some of the world’s most profitable software companies.
Changing business models will put much of the industry’s AUM in flux, creating opportunities for new winners and losers to emerge. One thing will not change, however: A future where asset managers manage fewer assets is one where investors still need investment selection and portfolio-building expertise.
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