Passive investing resumes its march

After slowing last year, a stream of cash into funds that track markets is picking up again.

  • By Dawn Lim,
  • The Wall Street Journal
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A decadelong shift of money and power from old-fashioned money managers into index funds resumed its march in 2019.

Last year, net inflows into funds that track markets fell about 30% from the year before, according to Morningstar data. Some firms said fears around slowing global growth and a particularly volatile stock market led investors to take money from asset management’s most popular products.

The 2018 slowdown was noticeable at BlackRock Inc. (BLK), Vanguard Group and other large money managers. It led to concerns from some investors about whether a major growth engine for the firms was sputtering.

But now, a stream of cash into funds that track markets is picking up once again.

The recent pickup came ahead of BlackRock and State Street Corp. (STT) reporting earnings Friday morning. A rise in flows could help soften the impact of a continuing price war.

Net inflows into index-tracking U.S. mutual funds and exchange-traded funds rose by around 50% in the second quarter of 2019 from a year earlier, according to Morningstar data. For the year ended June 30, passive net inflows increased by about 1% after contracting in the year-ago period. Net inflows measure the difference between money coming in and leaving.

“There’s been some swings quarter-to-quarter, but overall passive flows have been very strong the past three years,” said Morningstar analyst Kevin McDevitt. “It’s possible the momentum could slow, but it’s difficult to see a reversal anytime soon.”

Indexing giant Vanguard Group illustrates that pickup.

The firm’s full-year net inflows fell between 2018 and 2017. But Vanguard’s overall second-quarter net inflows this year of $57.3 billion rose nearly 40% from the same period in 2018, according to the latest preliminary numbers from the firm.

The Malvern, Pa., firm reported $54.2 billion in net inflows into indexed strategies in the second quarter, up about 35% from a year earlier.

Vanguard’s assets under management grew to about $5.6 trillion as of June 30 from $5.1 trillion a year ago, getting a boost during a quarter in which the U.S. stock market hit new records.

The recent uptick for Vanguard and others shows that indexing giants continue to be cash magnets. These firms have gone from bit players on Wall Street to some of the most influential firms in all of America. They now oversee trillions of dollars in investments.

But they face growing scrutiny over how they are wielding influence over American corporations as they become bigger shareholders. Virtually every S&P 500 (.SPX) company has either BlackRock, Vanguard or State Street as an at-least-5% owner, according to a Wall Street Journal analysis.

As the passive-investment giants continue to grow, active managers have been squeezed again this year.

Net outflows from actively managed funds in the second quarter of 2019 roughly doubled from the year-ago period, Morningstar data show. In the year ended in June, their net outflows deepened more than 10-fold.

Some investors believe that active managers could still rebound should the stock market face a sustained period of weakness. Many stock- and bond-picking firms are also exploring ways to diversify their businesses and bring in new assets.

Among the active-management firms whose assets have increased is T. Rowe Price Group Inc. (TROW). Its assets rose to $1.13 trillion as of June 30, from $1.04 trillion a year ago, according to preliminary numbers from the firm.

Even so, a rise in assets doesn’t always translate into larger profits. Margins at all types of managers have been squeezed by the rise of low-cost indexing. Lately, there has been a fee war in many corners of the industry.

“If flows are good but you’re charging less, that’s a hard thing for asset managers to outrun,” said Kyle Sanders, an analyst at Edward Jones.

One way that both active and passive managers have looked to boost profits is by pushing more aggressively into more complex and lucrative strategies. Others have started to offer more funds that lock up investors’ cash for longer periods.

Within the passive-management industry, the pickup in flows was pronounced in U.S. equities.

Funds that track U.S. stock-market indexes took in roughly $267.3 billion in the year ended June 30, up more than 60% from a year ago, Morningstar data show. Actively managed U.S. equity funds saw net outflows increase by more than 3% in that period; they have suffered net outflows for every consecutive quarter since mid-2014.

Meanwhile, bond funds received an influx of new cash as investors sought safer bets amid a flare-up in trade tensions and mounting anxiety over an economic downturn.

Actively managed funds focused on taxable bonds took in $26.4 billion of net inflows in the year ended June 30, but that was a fifth of what they took in a year ago. They face a growing threat from passive funds. Those funds took in more than $170 billion in net inflows, nearly matching the year-ago period.

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