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Advisors Worry About Risk in Rising Passive Inflows

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Are advisors concerned about all the inflows into the passively managed exchange-traded fund space? The short answer is yes, according to a recent discussion with wealth management thought leaders on Tuesday in New York City.

The event – moderated by Money Management Institute’s president and CEO, Craig Pfeiffer – included John Moninger, managing director of retail sales at Eaton Vance, and Roger Paradiso, head of alternative distribution strategies at Legg Mason and chairman-elect of MMI’s Board of Governors.

Pfeiffer, Moninger and Paradiso discussed critical issues affecting the industry – in particular, the passive vs. active debate.

“You’ve got all this money coming into a set of structures – we’ll call it large-cap U.S. equities, to boil it down a little bit – and is there a fear that all that money going into a single asset class has risk? And no question about it,” Moninger said, “I hear that from advisors. And advisors would echo that one loud and clear.”

According to Moninger, advisors are “thinking about how do I try and manage the risk for my client while maybe even still offering passive investments.”

Passive funds are taking market share from active managers at an accelerating pace. Active funds experienced significant net outflows in 2016, losing more than $340 billion of assets. Passive funds benefited, gaining more than $500 billion in net inflows. 

Looking at ETFs specifically, Q1 2017 was a record-breaking quarter for U.S.-listed ETFs, as they attracted approximately $132 billion in the first three months of the year, according to the U.S. ETF Flash Flows report from State Street Global Advisors.

“How do I deal with this concentration risk that’s developing in the marketplace?” Moninger said. “I think no question that’s something people have to be paying attention to.”

According to research from Moody’s, passive funds will account for more than half of the assets in the U.S. investment industry within the next four to seven years.

And Paradiso agrees that this concentration risk is a “true worry throughout the industry.”

“I think it allows true advisors to then really be thinking about ‘Well, how are we going about that diversification so we can move away from that potential concentration risk?’” he said.

And while there is a concentration risk in the increasing migration to passive investing, it’s not as bad as in years past.

“I think it’s slightly different from years past where bad diversification was quantified as tech and telecom,” Paradiso said. “There was so much concentration in such a small area.”

Today, large caps may be getting some of the passive inflows, but according to Paradiso, “that’s a better place for it to go then a smaller sector.”

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