Mutual-fund outflows make managers vulnerable to downturn, Moody’s says

A
trader reacts as he watches screens on the floor of the New York
Stock Exchange in New York
Reuters/Brendan McDermid

• Investors are pulling money from actively managed US
  stock funds this year at the fastest year-to-date rate on
  record, according to Moody’s.
• The credit-ratings agency said this has made mutual
  funds vulnerable to the next market downturn. 
• “The lack of organic AUM growth at a time when asset
  markets are at historical highs is a cause for concern,”
  Moody’s said. 

It’s not getting any easier for stock pickers to hold on to their
clients. 

According to Moody’s, investors have pulled cash from actively
managed equity mutual funds in the US at the fastest year-to-date
pace on record. The funds lost $129.11 billion of investor
dollars from January to July, up from $99.88 billion a year
earlier, data compiled by the Investment Company Institute and
cited by Moody’s show.

Moody’s

The flight of money away from managers who meticulously pick
stocks and to exchange-traded funds is happening a bit faster
than Moody’s had forecast. The market share of passive
investments last year was nearly 35%, more than the credit-rating
agency’s estimate of 34%.

While the
active versus passive debate has been extensively
discussed, the vulnerability of stock pickers has not been
as obvious, according to Moody’s. That’s because the shift away
from active management has coincided with a nine-year bull
market, the second-longest in history. 

“As equity market values have risen over the past decade, asset
managers have experienced stable cash flow generation,” Stephen
Tu, a senior credit officer at Moody’s, said in a report on
Monday. “However the lack of organic AUM growth at a time when
asset markets are at historical highs is a cause for concern.”

With the growth of cheaper and commission-free trading apps, the
pricing power of mutual funds has eroded, and their business
model is under pressure. The average active equity manager’s net
expense ratio, a gauge of their fees, has fallen below 60 basis
points, according to Moody’s.

“Because investors’ shift toward passive products and the
continued net expense ratio deterioration of high-fee products
are trends that appear to be accelerating, asset managers are
more susceptible to equity market volatility and elevated
valuations,” Tu said. 

When the next inevitable bout of volatility slams the stock
market, more passive funds are likely to retain their clients
compared to active funds, Tu said. That’s because there’s added
pressure on active fund managers to outperform the market.

So far this year, large-cap mutual fund managers are delivering
on that mandate with the help of growth
stocks including Amazon
and Apple,
according to Goldman
Sachs. But even this trend poses a risk because a sell-off
could force many major investors out of the exit doors at the
same time. 

“The crowding risks in FANG stocks and the tech sector
still remain elevated,” Bank of America Merrill Lynch said in a
note on Tuesday. 

If stocks sell off and investors feel that mutual funds are no
longer beating the market, the floodgates of client redemptions
could intensify, Tu said.