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Strong markets powered assets under management (AUM) for the U.S. fund industry to near-record levels in the first quarter, but the sector’s rating outlook remains negative, according to Moody’s Ratings.

In a new report, the rating agency said industry AUM returned to its recent highs in the first quarter, as markets shook off expectations that interest rates may stay higher for longer than previously expected.

For the firms tracked by Moody’s, long-term AUM was up by 5.8% in the first quarter to US$16.6 trillion, and assets were up 14.3% on a year-over-year basis.

“During the quarter, market appreciation drove over 85% of the increase in assets, while net inflows contributed modestly to higher asset levels,” it said.

Excluding the largest fund managers (firms with over US$1 trillion in AUM), organic AUM growth remained negative in the first quarter, Moody’s noted, marking the 10th consecutive quarter of net outflows for small and mid-sized fund managers.

Net inflows went into fixed income, alternatives and multi-asset strategies, it reported, while listed equities saw net outflows, “suggesting that investors may still hold a partially risk-off sentiment.”

The rise in assets also drove growth in firms’ management fees, even as “seasonal declines in performance fees and higher payroll expenses drove sequential decay” in fund managers’ pre-tax earnings and margins, the report said.

While the growth in AUM has the industry poised for a positive performance in the second quarter, Moody’s said its outlook for the asset management industry remains negative.

“Although financial markets and asset managers’ AUM levels have experienced strong growth through the first quarter, there remains a risk that the operating environment will weaken, driven by slowed economic growth and persistently high interest rates,” it said.

“Shifts in the AUM mix will continue to weigh on revenue as investors have moved toward lower-fee vehicles and asset classes,” it noted. Further, “Organic growth continues to be a headwind for the industry, particularly in the higher fee paying active strategies,” it said.