The sell side impact of equity assets moving from active to passive

It is well known that Vanguard, BlackRock and other passive equity managers have seen substantial net inflows while many active managers have struggled with net outflows.

The effect of such a move is obviously negative for overall fee income for the buy side, as passive fees are typically under 10% of active fees, but the impact on the sell side is equally problematic.

Let's look at the mathematics :

Typical turnover of an equity mutual fund is around 100% per year, if we assume that half that turnover is executed at regular commission rates of 10bps and half is executed electronically at 2bps, every million dollars in an active fund generates annual commissions of $1200 ($1.0m*0.001 + $1.0m*0.0002).

Typical turnover of a passive fund is under 10% - in reality it's zero with static net flows and no changes in the index, still under 10% with those two factors (Vanguard's $180bn S&P Index Fund (VFIAX) has 3% turnover) . All of that turnover is executed electronically at a rate that we will assume is 2bps. As such each $1m in a passive equity fund generates annual commissions of >$40 ($1.0m*>0.1*0.0002 + $1.0m*>0.1*0.0002). Even this is generous as it assumes that a buy is offset by a sell, which is true in the case of index changes but not for net flows.

Consequently assets that move from an active equity fund to a passive equity fund generate at least a 97% and maybe as much as a 99% drop in revenues for the sell side.

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