MOODY'S WARNS: Mutual funds are bleeding cash at an unprecedented rate, and they're increasingly vulnerable to the next market meltdown
- 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.
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.