The world's hottest investment product is heading for a record-breaking year

According to the Terminator movie franchise, the battle between humans and machines isn’t supposed to start in earnest for at least another decade.

Someone forgot to tell the stock market.

By all indications, the machines are winning. Passive investments that don’t rely on active management by humans are expected to account for half of the US equity market in the next 24 months, according to Credit Suisse.

For those paying attention, the writing has been on the wall for some time now. US-listed exchange-traded funds saw $US283 billion in net inflows during 2016, taking aggregate assets under management to $US2.5 trillion, according to Citigroup. That dominance has only grown this year, with US ETFs absorbing a record amount in the first quarter. Credit Suisse forecasts that inflows for the full year will also be the most ever.

There’s a simple explanation for the shift: passive investment is cheaper.

“Fees are the dominant factor in determining flows,” a group of the firm’s analysts led by Craig Siegenthaler wrote in a client note. “We think ‘high fee to low fee’ is a better characterization of the current environment than ‘active-to-passive.'”

Of course, it doesn’t help matters for active managers that they have been underperforming their benchmark since 2013, according to Credit Suisse. While it’s certainly a tall task to beat an index like the S&P 500, which is in the eighth year of a bull market and continues to hit new highs, the futility has been prolonged enough to make investors question what exactly they’re paying for.

BlackRock, the world’s largest investor with $US5.1 trillion under management, has taken notice. The firm announced in late March that it will slash fees on some funds and increasingly turn to computing power to drive investing decision. That included a $US30 million fee cut for some of its actively managed funds.

Still, while 2017 is supposed to be a banner year for passive inflows, Credit Suisse sees an eventual slowdown coming in 2018 and 2019. That’s not to say they think the influence of ETFs and index funds will wane; rather, it simply means they see the current torrid pace of growth as unsustainable.

That can be at least partially explained by the looming spectre of the Department of Labour (DOL) Fiduciary Rule, which, if implemented, would open the door for tort lawyers to sue asset managers for not acting in the best interest of clients. The mere possibility of such a measure has driven the large emphasis on fees and accelerated the shift of flows from passive to active over the last two years, according to Credit Suisse.

But don’t throw in the towel on active management quite yet. Just adjust expectations as it shrinks in size.

“While asset management may no longer be a great business, it’s still a good business with low capital intensity, high margins, and positive revenue growth,” said Credit Suisse. “As the fragmented industry continues to consolidate, economies of scale will be awarded to the winners.”

NOW WATCH: Why you should never throw your teabags away after one use

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.