One of the most persistent stories that money managers have whispered to themselves before going to bed every night over the past decade is that passive funds will definitely be found out in next big bear market.

Sure, they murmured, their active funds were underperforming right now, but only because stupid central banks and their stupid ultra-easy monetary policy were “distorting” financial markets.

And those evil passive funds were also distorting markets! After all, why else would record-smashing cash machine Apple and the rest of the quasi-oligopolistic technology industry dominate equity market returns over the past decade? Right?

Surely — SURELY — when central banks finally wised up, markets would puke, investors would flee the siren-like allure of cheap beta and the value of active management would shine through once more? This narrative has periodically seduced financial journalists as well (including yours truly).

Lo and behold, the reality in 2022.


This is EPFR Global’s data on cumulative fund flows in 2022. The light blue and red lines show how passive equity and bond funds have attracted $379bn and $178bn respectively, while active equity and bond funds have lost $215bn and $442bn respectively.

This is hardly a surprise, as active money managers are once again mostly falling behind their promise to outperform when times are bad.

Morningstar’s latest Active Passive Barometer found that only 40 per cent of the almost 4,000 active funds it tracked survived and outperformed their passive peers in the 12 months through June. Only 29 per cent of active bond funds managed to do so. For what it’s worth, hedge funds aren’t doing much better, with the average fund down 6.66 per cent year to date, according to HFR (number of the beast!)

In other words, the annus horribilis of 2022 is actually burnishing the case for passive investing rather than destroying it — and reinforcing the trend of the past five years.



Why have passive flows been so resilient this year, anyway? One major reason is technical. A lot of big retirement funds have passive as their default, so there is mechanically constant money rolling towards index funds of various stripes.

However, this cannot explain it completely. Most of the money is going into ETFs rather than traditional plain-vanilla index mutual funds, which big pension plans generally don’t use (though they are widely used in model portfolios). I think that the main reason is simply investor psychology: We don’t like to feel duped.

If you tell someone that a S&P 500 index fund will be down 20 per cent if the S&P 500 falls 20 per cent, they’re not going to be happy when this comes to pass, but they can mostly accept it. But if you tell someone that you’re going to be nimble and protect them in a downturn, you’re going to have a difficult conversation if you suddenly find yourself down 30 per cent.

Of course, as the German proverb goes, trees don’t grow to the sky. At some point the shift towards passive will slow down. But it’s hard to see how it will reverse. Not that this will stop active managers from predicting that the next bear market will definitely be the one that proves them right.

Further reading:

How passive are markets, actually?

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