The global asset management industry has been disrupted, according to a new report by Moody’s Investor Services released Tuesday, December 6.

In the report, Moody’s downgraded the industry to negative.

A combination of trends, including lackluster active management performance, global regulation, and increasing cost consciousness has led investors to move away from actively managed funds and into low cost passive products like exchange-traded funds, or ETFs.

“Active management performance after fees continues to underwhelm,” says Moody’s Vice President Neal M. Epstein in a press release. “Investors are remaining cost-conscious as skepticism of active management’s value proposition increases.”

Furthermore, global regulation aimed at transparency is adding to fee pressures. The DOL Fiduciary Rule taking effect April 2017 aims to stop advisors from putting their own interests in earning high commissions and fees over clients’ interests in obtaining the best investments at the lowest prices. In the European Union, MiFid II is also trying to increase investor protection via regulatory oversight.

According to a McKinsey report published last month, the DOL regulation will be "one of largest shocks to the wealth management industry in over 40 years."

As active managers fail to justify fees, they have also becomemore dependent on market appreciation, rather than attracting new investor money, to drive AUMgrowth, according to Epstein in the Moody's report. "Organic growth remains a challenge for many active managers, while organic growth for passive managers outpaces the industry."

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Foto: sourceMoody's Investor Services

Meanwhile, money continues to flow into passive investment products, as can be seen in the chart. Competition between ETF providers is lowering passive costs and ETFs are increasing penetration in new asset classes like such as fixed income and emerging market equities and new channels like retirement, making the funds more attractive to investors.

This massive rotation has led Moody's to downgrade the global asset management industry as a whole to "negative" from a "stable" rating.

An upgrade to a stable rating would involve active managers improving performance and a stabilization of fees. Moody's sees a move to a positive rating as "unlikely at this time."

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Foto: source Moody's Investor Services

ETFs, or exchange traded funds, are one of the fastest-growing types of investment vehicles in the markets now. Because of generally lower costs and higher liquidity than mutual funds, ETFs have gone from $230 billion in assets toaround $4 trillion over the past 10 years. McKinsey sees a continuing "shake-out" where average asset managers will underperform that could potentially set another $8 trillion, or 25% of the US asset management market, into motion.

The downgrade by Moody's is significant, spelling trouble for the global asset management industry and average managers as we know it.

Another study conducted by Thrivent Mutual Funds (an active manager) last week found that index funds offer no assurance of outperforming actively-managed funds if a bear market ensues. Of course, Thrivent Mutual Funds is an active manager so it is in their interest to say so, but the study shows that during the two market crashes of the 21st Century, the S&P 500 and the Russell 2000 indexes significantly trailed their corresponding categories of actively-managed no-load mutual funds.

Passive products like ETFs have enjoyed strong performance during a sustained bull market. How they will fare compared to active managers in the midst of a bear market, rising interest rates and potential economic uncertainty remains to be seen.