- UK Equity funds saw £0.9 billion of retail outflows in July, according to industry data released by the Investment Association today
- The first month of the new government failed to staunch UK fund outflows which now total £56 billion since 2016
- Active funds are on course for another disastrous year of retail fund outflows, while passive funds march on regardless
- It’s going to take a tech crash to improve the fortunes of active funds
Laith Khalaf, head of investment analysis at AJ Bell, comments:
“You’d think things can only get better for UK fund sales, but they keep getting worse. The election of a new government failed to staunch outflows from UK equity funds in July, which now total £56 billion since 2016. News that the British ISA has been scrapped will no doubt prompt some to rue the potential boost to fund sales the new tax shelter might have created, but in reality a new ISA was never likely to halt the long running trends which have led to an exodus from UK equity funds. Especially seeing as many ISA investors already have high weightings to the UK stock market, and therefore could have taken out a British ISA without adding any more net exposure to the UK.
“When it comes to fund sales, performance matters, and the UK stock market has fallen significantly behind US and Global peers over the last decade. It’s by no means alone in being unable to match the blistering pace of US stock market returns, but long term UK fund performance has also lagged Japanese and European counterparts (see table below). Little wonder investors have been abandoning UK funds in favour of Global and US alternatives.
Table 1: 10 year total returns
Source: AJ Bell and Morningstar to 28 June 2024
“That’s particularly the case because retail investors are still technically overweight the UK stock market in their portfolios, if you’re using the global stock market as a benchmark. Increasingly investors are doing just that, as the rise of passive investing shows. This is taking its toll on UK fund sales, and active fund sales. Active funds saw £2.1 billion of outflows in July. That takes the total active outflow for this calendar year so far to £15 billion, and the total over the last three calendar years to an unprecedented £91 billion. For a long time active managers had the field to themselves, but the passive interlopers are gradually taking over the fund ecosystem (see Chart 1).
Chart 1. Investment Association retail fund sales
Source: Investment Association to May 2024
“The performance of active funds has done little to prevent investors switching lanes. Our latest Manager versus Machine report shows that just 35% of active equity funds in seven key sectors outperformed a passive alternative. It’s been better to be invested in the average passive fund in the Global or US sectors than it has to be invested in a top quartile active fund in any of the other major sectors in our report (see Table 1). This makes it clear that over the last ten years, investor returns have been driven by the choice of how much to allocate to the US stock market, and in particular a small cabal of technology stocks, currently dubbed the Magnificent Seven.
“Active managers are typically underweight this area of the market, and for good reason. The Magnificent Seven now make up a highly concentrated portion of a typical US tracker fund (see Chart 2). To simply match the index weight in these stocks, an active manager would need to allocate a third of their portfolio to them, with some pretty punchy positions in individual names. From a diversification point of view many active managers would baulk at that exposure, especially when holding an index weight in these companies simply guarantees index returns on that portion of the portfolio before charges, and underperformance after charges. That means the remaining two thirds of the portfolio would have to do a lot of heavy lifting to deliver what active investors want; to beat the index.
Chart 2. Mag 7 exposure of a US tracker fund
Source: iShares 30/06/2024
“Active fund performance in the Global and US sectors is therefore unlikely to improve significantly unless there is a tech crash which brings the Magnificent 7 back down to earth. Even then, it would probably need to be sustained for a reasonable period to feed though into longer term performance, and drive investors back towards active strategies. The tech correction of 2022 manifestly didn’t achieve that. Of course we may also be seeing support provided to the biggest players in the market by increasing flows into passive funds which allocate money to stocks based on their size. Active managers may well be looking at this chicken and egg dynamic, and wondering how they get back in the coop.”
