ISS Market Intelligence (ISS MI), a unit of Institutional Shareholder Services and a leading global provider of data, analytics, insights, media, and events solutions to the global financial services industry, announced the release of its State of the Market: Future of Retail Products report covering the 2023-2027 outlook for long-term funds in the U.S.
The report suggests that, after slumping in 2022, long-term fund assets under management (AUM) will rebound to historically normal growth rates over the next five years. ISS MI projects AUM growth will average 7.1 percent annually in the 2023-2027 period, with long-term assets rising to $29.8 trillion by 2027. With 2022’s down markets cutting valuations to size, most capital market forecasts anticipate improved returns across asset classes, boosting long-term AUM growth.
With poor fund performance weakening investor appetites and inflation eroding the public’s capacity to save and invest, the report expects fund sales to recover slowly from 2022’s decline. As organic growth reverts to historical trend, however, ISS MI expects long-term funds to net $2.7 trillion in sales through 2027—a 2.4 percent annualized growth rate.
Meanwhile, the report finds that, while U.S. equity fund flows are expected to rebound to a projected $197 billion in flows over the 5-year period, bond funds will still outsell stock funds by an estimated $1.8 trillion. While inflation and higher interest rates are likely to dampen interest in fixed income in the near term, an aging population should sustain relatively high demand for bond funds over the longer term. Overall, taxable and tax-free bond funds should soak up $2.2 trillion, or 81 percent, of total long-term flows in the next five years.
“Fund managers will face familiar challenges over the next five years, ranging from continued pressure from passives to aging demographics. Newer concerns such as high inflation also will put managers to the test, at least in the near term,” said Christopher Davis, lead author and Head of U.S. Fund Research at ISS MI. “However, the next five years should provide new ways for managers to package their intellectual capital. Significant changes in the industry’s asset class and product makeup provide opportunities for new winners to emerge.”
The report highlights a number of key industry themes and changes, including:
- Index funds will control more than half of long-term assets by 2027: ISS MI projects active fund share will fall from 53 percent to 44 percent over the next five years. This shift will boost index ETFs most, with the vehicle expected to net $2 trillion in new sales. On a net basis, the rebound in equity fund flows is expected to leave active managers empty handed. The prospects for active equity mutual funds are weakest, with an estimated $1.4 trillion in net redemptions over the next half decade.
- Outside of equities, a growing pie will boost active fixed income, alternatives managers: Although the report expects a majority of taxable bond fund sales to accrue to passive fund managers, active funds should get a large slice of the fast-expanding pie—an estimated $570 billion in net flows. Thanks to healthy organic growth, ISS MI anticipates active bond funds will grow AUM faster than active stock funds, despite stocks’ better return prospects.
- Niche areas like alternatives also offer active managers new avenues for growth: As alternatives’ market share grows from approximately 1.4 percent to 2.1 percent over the next five years, the asset class is projected to grow AUM by approximately 15 percent per year—the highest projected growth for any asset class over the period. ISS MI’s survey of financial advisors reveals growing interest from fund buyers but also worries over alternatives’ liquidity requirements, greater need for due diligence, and higher fees.
- Active ETFs will not arrest active management’s decline, but they will attract an increasing share of active fund assets: The fund-to-ETF conversion trend boosted active ETF assets considerably in 2022, and ISS MI expects active ETF market share to rise further from 1.4 percent to 2.3 percent over the next five years, translating into 17.4 percent annualized AUM growth and over $280 billion in new flows. The potential for rapid growth has already spurred heavy product development activity, with the number of active ETF launches far outpacing any other product categories in 2021 and 2022. Active ETFs are unlikely to reverse active funds’ market share decline, but further fund-to-ETF conversion activity and the underrated possibility of widespread ETF-as-share class distribution leave room for additional growth.
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