Index trackers reached a record high of £28 billion in retail inflows in 2024, while active funds saw £29 billion in outflows, continuing a three-year decline totaling £105 billion.
Laith Khalaf, head of investment analysis at AJ Bell, comments:
“Index trackers absolutely smashed through previous records in 2024, taking in £28 billion from retail investors. What’s particularly impressive is this was done against a backdrop of weak overall fund inflows, with total retail sales registering a modestly negative £1.6 billion outflow. If there’s not much lunch to go around, but you’re still gobbling up money like tracker funds are, that means you’re eating someone else’s. The result? Active funds saw £29 billion of outflows in 2024. That wasn’t a record because in 2023 active funds saw £38 billion of retail outflows, as they did in 2022. So, over the last three years active funds have waved goodbye £105 billion of retail assets. Ouch, to say the least.
Why is so much money going into passive funds?
“One of the big reasons so much money is flowing into passive funds is performance. AJ Bell’s Manager versus Machine report shows that in seven key equity sectors, only a third of active funds have outperformed a passive alternative over 10 years. A lot of that comes down to the exceptional returns generated by the Magnificent Seven, and the fact most active managers in the Global and US sectors are underweight compared to the index, and their passive competitors. It’s hard not to be, seeing as the Mag 7 now make up a third of the typical US tracker fund.
“We may be entering a more hazardous period for the megacaps of the US technology sector. AI undoubtedly presents a big opportunity, but also a threat, as showcased by the recent release of the DeepSeek model. Lots of money is being thrown at AI development, with a great deal of uncertainty about the size of the end market, and who will be at the front of the queue when it comes to collecting the rewards.
“This might give active fund managers some cause for optimism that size might not matter so much in future. Hope springs eternal. 2022 witnessed a big sell-off in the Mag 7 but did not see a shift from passive back to active. If investors are to shift en masse back to active funds, it’s likely to take a more sustained downturn in the US tech sector that feeds through into longer-term performance figures. In that scenario, the global stock market as a whole could well be struggling, and investors might not decide to invest in funds at all, resulting in a somewhat pyrrhic victory for active funds.
“The shift towards passive investing is not just about performance either. Cost and simplicity are key factors too. There are many more investors today than there were in the heyday of the star manager, but a smaller proportion of hobbyists. Many of them just want to park their money in a fund that offers them cheap and cheerful exposure to the stock market.
“A totemic example might be found in the default funds used in workplace pensions. When auto-enrolment was introduced, the coalition government put in place a charge cap of 0.75% on funds used as defaults. This effectively ruled out active management for all but the biggest schemes (who could negotiate discounts on administration and fund management fees). Consequently, huge chunks of the monthly contributions from pension schemes have been invested passively.
“We also live in a world where there is perceived safety in numbers. What’s the point of a pension scheme manager or a financial adviser taking a risk on an active manager when they are going to get it in the neck from investors if that manager underperforms? If a passive fund tanks, well, customers expect nothing more in a falling market.
Why is so much money flowing out of active funds?
“Just because passive funds are doing well doesn’t mean that active funds can’t enjoy some good times too, but outflows from the active fund industry over the last three years have been absolutely enormous when combined with weak overall demand for funds. Total retail fund sales in 2024 were minus £1.6 billion. That’s a vast improvement on 2023, when £24 billion was withdrawn from investment funds, and 2022, when there were £27 billion of net retail outflows. To put these numbers in context, during 2008, typically seen as not the best of times for markets, almost £5 billion was still invested into funds by retail investors. Against this backdrop, retail outflows from active funds have been off the charts, as the chart below shows.
Source: AJ Bell, Investment Association
“There are a number of reasons why overall fund sales have been weak in recent years. Inflationary pressures clearly limited the propensity of many households to save and invest money. Meanwhile rising interest rates meant disposable income that was stashed away was more likely to find its way into cash or paying down the mortgage, which clearly has negative implications for investment funds. Traditional investment funds are also facing competition from Bitcoin and chums, with seven million people in the UK now holding crypto, roughly the same number that hold a Stocks and Shares ISA. Most of this is probably small beer, but the small beers of seven million people still adds up to a hangover for investment funds.
“With 25% of industry assets now held in passive funds, the question is how much more road there is ahead of the passive machines. In the US, the amount of money in tracker funds has now surpassed that in active funds, if that provides a helpful indication.
UK rout continues
“UK equity funds also continued to see retail outflows in 2024, to the tune of £13.1 billion. Happily this wasn’t a record outflow seeing as investors chose to withdraw £13.6 billion from UK equity funds in 2023. Since 2016, £60 billion has now been withdrawn from UK equity funds. This can partly be explained by weak performance relative to global and US funds, which attracted almost all the cash flowing into equity funds in 2024. It can partly be explained by the rise of passive investing, which naturally favours a global approach.
“However, there is a more structural trend in place here which may well have further to run. Despite weak performance and large outflows, the UK All Companies sector is still the second most popular fund sector, after Global. This is a legacy of the many years when investors ploughed their savings into UK funds, before the influx of overseas investment options and cheap global passive funds. Meanwhile, the MSCI World Index now contains just a 3.5% allocation to UK shares. The fact the UK All Companies sector is the second most popular amongst UK retail investors suggests they are still heavily overweight the domestic stock market, compared to a global index. Relentless and large outflows are no doubt partly a reflection of the push-pull force of weak performance relative to the US. But UK equity funds are also suffering the slow and painful unwinding of investors’ high historical exposure to their home market.”
Source: AJ Bell, Investment Association
