Despite posting increased market share for the eight straight year in 2013, passively managed funds still have the potential to grow, note BMO analysts.

David J. Chiaverini and Richard Fellinger of BMO Capital believe rotation from fixed income to equities would continue in 2014.

Passive investments: 28% market share

According to the BMO analysts, passive investments, including indexed mutual funds and ETFs should remain popular with investors, despite garnering 28% of total long-term mutual fund and ETF managed assets. The analysts believe passive investments should continue to grow at the expense of actively managed funds.

The BMO analysts believe passives will continue to be preferred thanks to its low expense ratios, high liquidity of core products, and continued preference shown by fee-based financial advisors. The analysts believe such a trend would favor BlackRock, Inc. (NYSE:BLK) as it is a leader in managing passive investments.

Growth of passive investment

Rotation to equities

The BMO analysts point out that the ‘Great Rotation’ as the key investment theme of 2013 manifested itself only during the second half of 2013. Last year US mutual funds and ETF witnessed $430 billion of inflows into equity products, while fixed income saw outflows of $28 billion. The analysts point out this marks a departure from the relentless equity outflows and bonds inflows witnessed in 2011 and 2012.

The following graph highlights rotation to equities over the past few years:

Rotation to equites Passive Investment

The analysts anticipate such a rotation will continue through 2014 as they believe rising interest rates will continue to lead to negative returns on traditional long-duration bond funds. Moreover the analysts believe positive equity market performance should attract investors who have been playing ‘wait-and-watch game’ or underweighting in equities.

Despite end-January and early-February marked reversal of such a trend, the analysts believe the overarching equity inflow trend will remain in place.

The BMO analysts anticipate T. Rowe Price Group Inc (NASDAQ:TROW) would be the major beneficiary of such an equity flow trend.

Rotation within bonds

The BMO analysts believe fixed-income categories that should continue garnering assets despite the potential for increasing interest rate include unconstrained and non-traditional bond offerings. The analysts anticipate these categories will grow at the expense of traditional fixed-income products. They believe the alternative asset managers are in the pole position to derive benefit from this trend, since 100% of their credit businesses are already made up of non-investment grade products.

The analysts anticipate apart from all of the alternative managers in their coverage viz.: Apollo Global Management LLC (NYSE:APO), BlackRock, Inc. (NYSE:BLK), The Carlyle Group LP (NASDAQ:CG) and KKR & Co. L.P. (NYSE:KKR), selected traditional managers such as BlackRock and Legg Mason Inc (NYSE:LM) would also benefit from this trend.

BMO’s top picks

David J. Chiaverini and Richard Fellinger of BMO Capital prefer BlackRock and Franklin Resources as their top picks among the traditional managers. The following table summarizes the analysts’ price targets for traditional managers:

Price targets-Traditional managers

The BMO analysts prefer Apollo Global Management LLC (NYSE:APO) and The Blackstone Group L.P. (NYSE:BX) as the top picks among the alternative managers. The following table captures the analysts’ price targets for alternative managers:

Price targets-alternative managers