Passive investing is here to stay but will likely see slower growth rates as markets ‘normalise’, a new survey of global pension funds has found.
According to the report published by the UK-based Create Research, pension funds have doubled their exposure to index-style strategies since 2008 to represent about a third of assets under management.
The Create study, sponsored by Deutsche Bank-owned funds management firm DWS, says the rise of passive investing has been buoyed by ‘unconventional’ monetary policies that have floated all asset prices upwards.
But as central banks unwind crisis settings – a process already underway – that would have “some effect on passives, more likely a slowdown in growth than a sharp reversal in their inflows”, the report says.
“Passive investors could suffer full market losses when the tide turns – possibly more than active investors, who can proactively switch into cash,” the study says. “Notably, only 10% of respondents expect passives to replace actives.”
The Create survey of 153 pension funds across 25 jurisdictions (including Australia) representing collectively almost €3 trillion, found 35 per cent of respondents tipped passive funds to lose favour as active strategies outperformed.
But the majority (60 per cent) said passive and active funds would remain as “equal partners” in diversified portfolios while 42 per cent expected indexing to become a “permanent feature” of investment strategies.
“However, contrary to media reports, passives are not perceived as an all-weather choice that work in good times and in bad or as the perfect substitute for actives,” the report says. “Instead, pension plans have adopted an eclectic approach that sees the world of investing as cyclical and self-correcting. Like the ocean tides, styles go in and out of fashion, making it essential to recognise the drawbacks of passives as well as their complementarity with actives.”
Almost 70 per cent of those surveyed said passive funds overweight to “yesterday’s winners and overinflate valuations” while about half cited reduced diversification as a likely side-effect of en-masse index investing. Just over 40 per cent of respondents agreed that passive investing could make “booms and busts more likely due to price momentum”.
Despite the downsides, the survey found most respondents (61 per cent) saw passive investing as a good low-cost option in a “low return world”. Close to half said indexing could enhance core ‘buy-and-hold’ strategies as 41 per cent looked for a best-of-both-worlds mix of active and passive in a balanced portfolio.
Overall, pension fund exposure to passive investing is likely to grow about 6 per cent each year for the rest of this decade “on an asset-weighted basis”, the Create report says.
While equities dominates the passive allocations with 82 per cent of respondents indexing at least some of that asset class, the strategy was also used in: fixed income (54 per cent); multi-asset funds (20 per cent); commodities (13 per cent); and, real assets (7 per cent).
“With the exception of fixed income, these asset classes are likely to extend their coverage over the rest of this decade,” the report says. “… The upshot is that passives are moving into the buy-and-hold portfolios of pension plans. As for the composition of growth, it is more likely to be skewed towards three types of passives: smart beta and other factor-based strategies, ESG strategies or other thematic strategies.”
Create chief, Amin Rajan, says the passive phenomenon has triggered “alarming predictions about the future of active funds” that require a more balanced analysis.
In the report foreword, Nicholas Moreau, DWS head, said: “What we have seen is a fundamental reshaping of asset management, with some strategies standardised and made easily accessible at low cost, with the result that investors now have an unprecedented level of choice to help them meet their asset allocation goals…
“Importantly, this new landscape provides an opportunity for good passive and active asset managers to differentiate themselves from the competition.”