Do the expected trends among institutionalinvestors—Fidelity's survey accounts for $29 trillion, or half ofglobal institutional assets under management—portend anything forthe $5 trillion U.S. 401(k) plan market? (Photo:Shutterstock)

Around the globe, institutional investors are signaling a shift away fromtraditional passive investment strategies to actively managedstrategies, as pension plans, insurance companies, and otherlarge investors brace for a low-return environment and increasedvolatility over the next six years.

Fidelity's annual Global Institutional Investor Survey, whichtakes the pulse of 905 large investors across 25 countries,suggests the considerable momentum behind passive index investing over the past twodecades is likely to see a pendulum swing in the oppositedirection.

“Institutions realize that in the long-term, market activity mayno longer be enough to generate returns, so they have to worksmarter to reach their goals,” said Jeff Mitchell, chief investmentofficer, Fidelity Institutional Asset Management, in a pressstatement.

Fidelity, and others, are predicting lower global growth for theforeseeable future. Fidelity is projecting global GDP growth of 2.1percent annually over the next two decades, compared to the 2.7percent average over the past 20 years.

Meanwhile, many institutional investors are maintaining returntargets of 6 percent to 7 percent, Fidelity says.

Achieving those returns will require some fundamental shifts instrategies.

“Institutions are restructuring their portfolios to reflect thischanging investment ecosystem, whether by increasing allocations tocertain investment styles or asset classes, or embracing newinvestment strategies,” added Mitchell.

Active to passive and back to active

The erosion of actively managed mutual fund dominance over thepast quarter century has been well documented.

As of December 2017, passive strategies accounted for 37 percentof U.S. mutual fund and exchange-traded fund assets undermanagement, according to the Federal Reserve Bank of Boston. In2005 it was 14 percent, and in 1995 it was a mere 3 percent.

In 2018, passively managed U.S. equity funds increased theirshare to 48.1 percent of the market, according to Morningstar, withthe 50 percent threshold expected to be surpassed this year.

But across the globe, more institutional money will move toactive strategies in pursuit of alpha against a low-returnbackdrop.

Among institutions investing more than $1 billion, 41 percentexpect to increase allocations to actively managed styles, withonly 8 percent saying they will decrease active strategies. Andjust as telling: 42 percent say they will decrease allocations totraditional passive, or purely indexed styles, with only 5 percentlooking to increase passive allocations, according to Fidelity'ssurvey.

Smaller institutional investors are planning similar, thoughscaled-down, shifts. About a quarter of those with less than $1billion in assets say they will increase active strategies, with 20percent expected to decrease active strategies. Another 25 percentsaid they will decrease traditional passive allocations.

Non-traditional passive strategies—smart beta and quantitativestrategies that deploy cash to custom-built indexes—will also getmore attention, with a quarter of investors with more than $1billion in assets looking to increase money in that direction, and18 percent of those with less than $1 billion looking to do thesame.

“Overall, the historical trend exhibited by institutional flowsinto passive index funds may be reaching a plateau, amid lowerreturn expectations for pure beta, greater optimism fornon-traditional passive or systematic approaches, and the perceivedneed to consider adding active risk in certain asset categoriesthat are less easily represented by index funds,” according toFidelity's report.

 What about 401(k)s?

Do the expected trends among institutional investors—Fidelity'ssurvey accounts for $29 trillion, or half of global institutionalassets under management—portend anything for the $5 trillion U.S.401(k) plan market?

Institutional investors benefit, some would say, from moreoptions than those available in rank-and-file defined contributionplans. For instance, large investors tend to direct highallocations to private equity and lower allocations to U.S. andother developed country equity funds.

Nonetheless, style shifts among the biggest institutions cantrickle down, says Judy Marlinski, president of FidelityInstitutional Asset Management.

“Larger institutions may be leading the trend towardrestructuring their portfolios, but we expect these trends to beadopted more broadly throughout the wealth management industry,”said Marlinski.

As institutions are cutting allocations to traditional passiveinvesting and developed markets, larger chunks of 401(k) assets arepassively invested in U.S. equities.

According to data from the Plan Sponsor Council of America, thepercentage of assets for all plan sizes invested in passivelymanaged domestic equity funds was 10.8 percent in 2010, and 16.5percent in 2017. The percentage of actively managed U.S. equityfunds remained flat, at about 18.6 percent.

Domestic passive investing increased its share among all plansizes. But the 50-to-199-participant segment shows the greatestfavor for passive strategies: Passive U.S. equity funds accountedfor 19.2 percent of plan assets in 2017, compared to activelymanaged equity funds' 10.3 percent share, according to PSCA.

Some defined contribution plans were included among Fidelity'sinstitutional survey.

They were the most likely to anticipate continuing the statusquo. Among all institutional respondents in Fidelity's survey,three-quarters expect investment strategies to change by 2025.

But within the DC segment, half said strategies would stay thesame or were unlikely to shift, according to Fidelity.

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