Too big to fail? Twenty funds capture 87 per cent of investment flows in a month
A handful of the highest-raising investment funds are scooping the vast majority of all money invested in a month, raising concerns that large passive managers are becoming “too big to fail”. On average, 87 per cent of monthly net investment flows go toward the top twenty funds alone, according to exclusive data from EPFR.
EPFR, part of Informa, tracks investment flows across 135,000 funds globally and covers USD49.5 trillion assets under management.
The data provider studied the period from February 1996 to January 2021, with the list of highest-raising funds fluctuating from month-to-month.
In January 2021, this list was topped by Vanguard’s all-cap ex-US equity fund. It also included US bond funds from Vanguard and iShares, as well as money market funds from Morgan Stanley, Fidelity, Wells Fargo, JPMorgan, and BlackRock.
This level of concentration is a “classic example of the rich getting richer”, according to Cameron Brandt, director of research at EPFR.
In recent years, Brandt says that large pools of automatic pension deductions from employee pay-packets have increasingly gone into a slate of ETFs from the largest passive managers, including BlackRock, Vanguard, and Fidelity.
This has led to extraordinary growth for the largest asset managers. In June, BlackRock hit a new peak of USD9.5 trillion assets under management. Almost a third of this, USD3 trillion in assets, was in the firm’s ETF arm, iShares.
“I think this advantage is only going to get greater,” says Brandt. He notes the “yield-starved environment” that has set in over the past decade, with central banks pushing down interest rates to record lows.
“When you're faced with minimal or extremely modest opportunities to get yield, especially with any degree of safety, the obvious way to maximise your returns is to cut your costs,” explains Brandt.
Investors have picked up extra yield in avoided costs, by shifting money out of actively managed funds and into passive options.
The Investment Company Institute estimates that passive index funds now hold USD11 trillion, up from USD2 trillion a decade ago. In that time, active equity funds have shed USD1 trillion in assets, according to Morgan Stanley.
By March 2020, passive funds made up 48 per cent of the assets in equity funds and 30 per cent for bond funds, according to research from Federal Reserve Bank of Boston. Both shares were less than five per cent in 1995.
Concerns have now been raised about the concentration of investment flows, since it can distort market signals and destabilise entire economies.
Large passive investors already wield outsized influence in emerging market economies, where they are often the largest source of foreign credit.
“A small number of nonbank financial intermediaries dominate the global asset management industry, managing portfolios that are often large relative to EME markets,” notes a recent paper from a working group at the Bank for International Settlements.
“Passive investment strategies and other practices in the asset management industry can give rise to herd behaviour and contagion, such as when changes to a bond or equity index trigger a rebalancing by the portfolio investors tracking the index,” its authors write.
In developed countries, heavily-concentrated investment flows can also mask usual market signals.
“In theory, concentration definitely stifles the price and momentum signals that we've historically relied on to make some kind of judgment on whether the market is fairly valued,” says Brandt.
“The issue is that at the moment, I think those top twenty [funds] are in the category of too big to fail.”
Nine out of 10 companies on the S&P 500 currently have as their largest single shareholder, one of the ‘Big Three’ asset managers: BlackRock, Vanguard and State Street. In a major crisis, these managers’ highly-liquid passive index funds could be left struggling to meet investor redemptions.
“There's an assumption, increasingly, that there's a central bank ‘put’ on the American [funds], so that if they run into trouble, there’ll be a Fed facility opened up the day after,” says Brandt.
Volatility has already been suppressed by central bank interventions over the past decade. Since May 2020, the Federal Reserve has ploughed almost USD9 billion into a suite of corporate bond ETFs to shore up financial markets against the coronavirus pandemic.
“The circumstances have aligned in a way that certainly favours the big ETF providers, thanks to economies of scale, the substitution of saving on management costs because you can't get yield. There’s also the fact that one central bank has already set the precedent for intervening via ETFs to prop up an equity market, that would be the Bank of Japan,” says Brandt.
The Bank of Japan is the largest owner of Japanese stocks, after years of purchasing ETFs tracking the major equity indexes. The central bank announced it would be abandoning its USD55 billion annual target for ETF purchases in March.
“In a lot of developed markets, people feel that it's better when the government is heavily involved, and there are fewer nasty shocks. I think most people would rather trade yield for security,” says Brandt.