Passive investing will overtake active investments in the U.S. in the next few years as the market share for passive products is expected to surpass 50% of assets under management (AUM) within the next four to seven years from 28.5% today, driven by the continued popularity of ETFs and index mutual funds, according to a new report from Moody’s Investors Service Inc.
“We believe that the passive phenomena is more appropriately viewed as the adoption of a new technology,” says Stephen Tu, vice president and senior analyst with Moody’s, in a statement. “Investor adoption of passive and low-cost investment products will continue irrespective of market environments and we estimate that passive investments will overtake active market share by sometime between 2021 and 2024.”
The credit-rating agency’s prediction is based on both a linear regression model of market share vs time and by fitting recent AUM data to a diffusion model that projects near-term market share. Moody’s says its forecast using the linear regression model is “very conservative” as it’s based on prior periods when passive investing was viewed with greater skepticism.
Moody’s also says it believes “smart beta” funds and multi-factor funds, “will be the next hotspot for investor dollars” in the U.S. A shift to these funds “will lead the industry into a lower-cost environment of active management, while ‘robo-advisors’ are on the cusp of gaining significant traction as financial and investment technology improves,” the report says.
The U.S. market is leading the shift to passive investing, but Moody’s says it expects to see growth in other markets as well, as the rest of the world has seen a smaller penetration for passive products. “This is due to less awareness of passive products or sales practices, which do not favour the best interests of investors,” the report notes.
“However, Moody’s believes the potential for overseas growth in passive investing has room to grow as markets mature and investors become more aware of the products,” the report adds.
“Over time, we expect passive adoption in the European Union and Asia to follow a pattern similar to the U.S., provided that global transparency and communication improves and that global financial markets continue to mature and become more investor-friendly,” Tu says.