Multi-asset funds and passive equity funds were the big winners in 2019, but property and active funds were hit hard by outflows. By Edward Glyn, head of global markets at Calastone.
Calastone is uniquely placed to monitor global fund flows. We power £190 billion of investment value across our global funds network each month, connecting the world’s financial organisations, and enabling retail and institutional investors to buy and sell their fund holdings at minimal cost and with minimal risk, friction-free. Our monthly Fund Flow Index (FFI) monitors the latest trends in the UK, as they happen.
2019 saw very mixed fortunes for the industry. The year was marked by risk aversion in the face of domestic and global political and economic uncertainties as well as high asset valuations. Stock markets strengthened sharply towards the end of the year, but January has already shown how sharp reversals can hit hard. Inflows across all funds fell by two-fifths year-on-year to £23.1 billion.
Of the four main asset classes, equity funds, which had been on track for their first annual outflow on record, pulled out a dramatic 11th-hour reversal in December and ended 2019 with a small surplus, thanks mainly to the post-election appetite for UK equities. But firms will lament inflows of just 19p of new capital for every £100 in equity assets under management.
Fixed income funds maintained healthy inflows, but mixed asset funds were the big winners, enjoying another strong, steady year of new capital, worth £6 for every £100 under management. Property funds, however, suffered their worst year on record, as investor cash fled the sector at the rate of £1 for every £15 invested.
Deeper structural trends in the asset management industry were clear to see in 2019. Property funds are suffering from the tension between their illiquid asset bases and their open-ended structure, while the rise of index funds and the poor publicity around some active funds means that two-thirds of equity flows in the last four years have been into passive funds, despite them only representing one-third of equity assets under management. And then there are the trends that come and go, such as the gold rush into absolute return and alternatives between 2015 and 2017 that has now gone into reverse.
The problem for the property sector is a tough nut to crack. Property is extremely well suited to the long-term investment horizons of people’s pension funds (and to a lesser extent ISAs), can be a good income generator, and it also provides the benefits of diversification. But the savings industry structurally favours open-ended fund wrappers, which come with the implication that cash can be withdrawn on demand. Yet this wrapper is undermining the viability of the asset class. In a year of record outflows, some fared better than others, but net selling has hit the whole sector, and one major fund was forced to suspend dealing. January has seen continued outflows, meaning that property funds have now shed capital for a record 16 consecutive months. Regulatory change is surely inevitable.
Equity funds also had a turbulent year in 2019. In particular, the fortunes of index funds contrasted sharply with actively managed funds. While the former enjoyed their best-ever year of inflows with £6.7 billion of new capital, the latter endured their worst, as investors withdrew an unprecedented £5.4 billion. Two factors are at work. The first shows the clear long-term direction of travel – passive funds will eventually overtake active funds as investors increasingly value the low fees and relative simplicity of index funds. There’s a very long way to go still – passive funds would have to roughly double in size just to reach parity with their active counterparts, or the latter would have to halve. It would take 20 years for that to happen if 2019 were repeated every year from now on. But that day is coming.
The second factor relates to short-term investor behaviour at times when confidence is weak. In these times, active funds bear the brunt of selling, while passive funds are relatively unscathed. By the same token, a sudden upturn in confidence, like we saw in December, is far more positive for active funds. The significantly lower two-way trading volume for passive funds (even though this results in rather strong, steady net inflows) is evidence that passive funds are cemented into regular savings plans via ISAs and pension wrappers; investors clearly do not tinker with their holdings that much. By contrast, they trade their active funds much more actively.
This shows that there is still a strong role for active funds to play in the future. If they provide the spice for investors, while passive funds provide the basic nourishment, the two flavours can work well together as part of a balanced portfolio. The key for active fund managers will therefore be to have differentiated products with real active bets, as opposed to cautious benchmark-hugging.
The final point is philosophical. For markets to be efficient, it’s not possible for all capital to be in index funds – the more funds are simply copying the index, the more opportunities there will be for active managers to outperform.
Fund flows are fundamentally determined by how much capital investors can deploy over the cycle, but they are also influenced by the manner in which people save. For example, while regular savings plans have increasingly come to favour mixed asset funds, the ebb and flow of markets also spurs investors to deploy additional capital more nimbly: they are spotting opportunities as they arise, as we saw in 2019 with the surge of optimism around UK equities in December, or pulling money out if market conditions deteriorate, as they did in the summer.
The UK’s asset management industry is a jewel in our financial services crown, enabling savers to place their capital where they believe they can achieve the best long-term returns, with a range of options that can meet any individual’s risk appetite or need for diversification. And with interest rates showing no sign of increasing in the medium term, there is no doubt that funds will remain the most compelling option for most long-term investors for the foreseeable future.
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