Passive Market Share to Overtake Active in 2 Years: Moody's

The shift to passive products is also reflected in the increased pace of M&A activity, according to Moody's. This is even moreso as acquirers seek out passive ETF assets.

However, Moody's notes that there are not many ETF franchises of scale for sale, and acquirers risk overpaying for these assets given their scarcity and pricing trends within the ETF industry.

Market developments in the past few years have also favored the trend toward lower-fee passive investment products, according to Moody's.

Most notably, Fidelity launched a suite of zero-fee ETFs, and other managers have followed suit. "Whether these products in and of themselves gain significant AUM, the more meaningful impact is to the psychology of the marketplace where credible product offerings at lower price points are established," the Moody's report states. "In the larger context of pricing, there were already products priced below 5 bps, and the theoretical lower bound could well be below zero given fund managers' ability to generate income from securities lending."

Meanwhile, in the active arena, the transfer of capital from the larger number of average active managers to the smaller number of superior active managers is inherent to the nature of markets.

According to Moody's, the goal of "alpha generation" can better be thought of as "error collection," just as a champion poker player wins earnings from others, and does not simply generate a return without considering the pool of potential winnings in the casino.

"Over time, only the best players will survive, leading to a more difficult game," the report states. "Similarly, active management could become more difficult over time, as a growing number of below-average active managers drop out or see their assets continually decrease."

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