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US passive investing to overtake active in four to seven years, says Moody’s

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The popularity of passive investments, including ETFs and index funds, will continue to outpace active investments and achieve a leading share of the US market by 2024 or sooner, according to Moody's Investors Service.

Passive investments account for USD6 trillion of assets globally and 28.5 per cent of assets under management (AUM) in the US, a figure poised to exceed 50 per cent in the next four to seven years.
 
"We believe that the passive phenomena is more appropriately viewed as the adoption of a new technology," says Moody's vice president – senior analyst Stephen Tu. "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 report "Asset Managers – Global: Passive Market Share to Overtake Active in the US No Later than 2024," reached its conclusions using two approaches: a linear regression of market share versus time, and by fitting recent passive fund AUM data to a diffusion model which projects near-term market share. 
 
Moody's says its forecast using a linear regression model of predicting the future passive investment adoption rate is very conservative, since its lookback period, 1996 – 2016 falls during a time when passive investing was viewed with greater scepticism. Under this method, passive investing will dominate the market in seven years. Its second approach uses a diffusion assumption model which melds well with market share data since the financial crisis and indicates a period of four to six years for passive funds to reach 50 per cent market share relative to active.
 
Additionally, owing to potential expected return profiles and cost advantages, Moody's perceives smart beta and multifactor funds will be the next hotspot for investor dollars and will lead the industry into a lower-cost environment of active management, while "robo-advisers" are on the cusp of gaining significant traction as financial and investment technology improves. 
 
While passive investing has experienced a surge in growth in the US, the rest of the world has seen a smaller penetration, approximately 5 per cent to 15 per cent. This is due to less awareness of passive products or sales practices which do not favour the best interests of investors. 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. 
 
"Over time, we expect passive adoption in the EU and Asia to follow a pattern similar to the US, provided that global transparency and communication improves and that global financial markets continue to mature and become more investor-friendly," Tu says.

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