After $1.8T active fund exodus, has the investment industry reached peak passive?

While active mutual funds' decade-long record of outflows has only deepened in recent years, asset managers might do well to position themselves for a tipping point in the ascent of passive investing.

That's according to Deloitte's latest Investment Management outlook, which outlined several shifts across global investment markets, signaling key trends in active and passive strategies, alternative investments, and the growing role of private credit.

Among several topics, Deloitte's newly published report took a deep dive into active mutual funds in the US, which marked their tenth consecutive year of net outflows in 2023. Active mutual funds, which have been under pressure for their underperformance compared to benchmarks, saw net outflows of more than $1.8 trillion between 2022 and 2023, a sharp increase compared to the cumulative $2.1 trillion outflows recorded between 2014 and 2021. Alongside the decline in active management, passive index funds continued to attract inflows, though at a slower pace over the past six years.

“Last year, net inflows to index mutual funds were a small portion of what they were in 2017,” Deloitte stated, reflecting a growing sense that passive investing may have reached its peak. The report suggests this dynamic could create an opportunity for active managers particularly as actively managed ETFs gain traction, capturing 23 percent of ETF inflows in 2023 compared to just 9 percent five years ago.

Turning to the alternatives sector, the report said hedge funds exceeded their long-term average performance last year, despite continued outflows. “Geopolitical uncertainty and shifting investor preferences toward more liquid and transparent investment vehicles likely resulted in continued net fund outflows from hedge funds,” it noted.

Meanwhile, private capital fundraising stalled, leading to stagnant AUM for 2023, although market participants expect a resurgence in deal activity over the next two years as players look to deploy their built-up dry powder. Private credit has continued to see rapid expansion, with global assets reaching $2.1 trillion in 2023. That momentum has continued into this year, Deloitte said, with a number of noteworthy partnerships between private credit managers and Wall Street banks. “These alliances are redefining relationships, providing mutual benefits,” the report stated, noting opportunities for banks to capture additional capital for their clients while investment managers to secure exclusive access to deal flows.

The report also highlighted the rise of evergreen fund structures, such as interval funds and business development companies, as vehicles to attract non-institutional investors. These funds reached a record $350 billion globally in 2023, doubling in number over the past five years. With the growth in evergreen funds and other SEC-registered products like private equity tender offer funds, investment managers are increasingly turning to financial advisors to educate clients about the potential diversification benefits these structures offer.

"However, some advisors believe that investment managers do not provide them with sufficient materials to educate clients about alternative investment," Deloitte said, adding that firms have moved to address the need either with their own platforms or partnering with third-party research firms.

"Over the coming year, investment management firms that expand into private credit offerings, particularly across retail distribution platforms, and make client education an integral part of their product strategy may achieve greater success," it said.