There will be a shift from market cap-weighted index funds towards smart beta, ESG and other thematic strategies as a result of the increase in popularity of passives, according to the Association of the Luxembourg Fund Industry (ALFI).

The report, produced by PwC Luxembourg, entitled Beyond their Borders: Evolution of foreign investments by pension funds, said the rise of passives is a “foundational change” in the way pensions manage portfolios.

The association predicted passive funds would see their assets under management (AUM) jump to $36.6trn by 2025, up from $23.2trn in 2017, in response to the need to show value for money.

Despite this however, the report said active funds would remain the largest part of the pension fund industry.

“As passives continue growing, pension funds will need active managers to deal with some of the inefficiencies that may result from a passive driven market,” it added.

As part of this, the report referenced a DWS survey of global pension funds, which found just 26% identified ETFs as their preferred investment vehicle.

While the shift from active to indexing is alive in the pension funds space, they do not necessarily need the intraday liquidity ETFs offer as ultra-long-term holders of capital compared to other investor types.

ETF Insight: Pension fund attitudes to ETFs evolving despite hurdles

Furthermore, when buying a mutual fund, they are guaranteed to buy in at the NAV meaning no spreads while with an ETF, because it is traded on exchange, there will always be a slight premium, however small that is.

The survey did find the number of pension funds using index funds increased from 48% to 53% while 26% invest in smart beta strategies.

The report concluded: “Looking forward, a shift from market capitalisation-weighted indices towards smart beta, factor-based, ESG and other thematic strategies is to be expected as a result of passives becoming increasingly popular.”

Title: The rise of alternatives and passives

PwC <a href=ALFI" width="1617" height="581" />