When Will Active Managers Feel the Pain?

Jeremy Glaser: From Morningstar I'm Jeremy Glaser. There's been question marks about the future of active management, but by many measures active managers are as prosperous as they've ever been. I'm here today with Russ Kinnel, he's our director of manager research, to look at this paradox.

Russ, thanks for joining me.

Russ Kinnel: Glad to be here.

Glaser: Let's start with the prosperous question. There's been a lot of talk about this rise of indexing really eating at active managers. But by lot of measures, in terms of assets, active managers are doing pretty well.

Kinnel: That's right. Today we stand at $11.7 trillion in the U.S. in actively managed funds, that's the most it's ever been, that's almost 3 times what we had at third quarter '09. And of course, the reason is that even though people are moving some money out of indexing, they are not doing it as fast as the market's going up. You have this tremendous appreciation. Even though on the one had it seems like tough times for active management, it's also a great time for active management. They are running a huge amount of money. The market's really been kind to active management.

Glaser: And even if they are managing that much money, fees are lower, they are collecting less money on that pot.

Kinnel: Fees are lower, but obviously in dollar terms they are still collecting more than they've ever collected. They are still making more profits than they ever have.

Glaser: You did talk about some of those outflows, about the moves to indexing. When you look across strategies, what percentage are in outflows today?

Kinnel: Within actively managed U.S. equity funds, two thirds of funds are already in outflows. When you think about that, that's actually pretty dark sign for active management, because we are in a bull market, things are great. Usually flows follow performance, and you've had really strong performance in active and index alike. And yet people are really bailing on their actively managed equity funds today. It's a dark sign for sure.

Glaser: So if we were to see a downturn that could get pretty ugly fast. When you look across the market, you just talked about U.S. equities, are there other parts, maybe international equity, where we are seeing active managers hold up a little bit better in terms of outflows?

Kinnel: One positive for active management is that outside of U.S. equity active management is still being very popular. If you look to fixed income and if you look at foreign equities largely they've had a lot of strong inflows. However, in the third quarter of this year we saw that pivot. In the third quarter you had net outflows of $15 billion out of international equity, $19 billion in inflows to international index funds. That's another thing to worry about for active management because again if international is going to become like U.S. equity, all of a sudden they are facing another really big challenge as investors start to buy into indexing overseas as well.

Glaser: In some ways then, great time to be active manager, but maybe some reasons to think that the future might not be as rosy.

Kinnel: That's right. If you think about, right now the typical fund might have, say, 20% appreciation a year and, say, 10% outflows. If instead the market goes down we go from 20% appreciation to maybe 25% or 30% depreciation and the outflows are going to accelerate, so maybe go from 10% outflows to 25%, now instead of having a big victory on appreciation and some outflows, both could get worse in a bear market. There is definitely some reason to be concerned if you are an active manager.

Glaser: Russ, thanks for sharing this today.

Kinnel: You are welcome.

Glaser: From Morningstar I'm Jeremy Glaser. Thanks for watching.