Passive’s no bubble as active retains market control

This analysis is by Bloomberg Intelligence Lead ETFs Analyst Athanasios Psarofagis. It appeared first on the Bloomberg Terminal.

The trend toward passive investing has accelerated in the past decade, boosting the asset share of indexed mutual funds and ETFs to 52%, or $15.4 trillion, of the almost $30 trillion invested in US stock and bond markets. That’s been driven mostly by the shift toward equity ETFs and away from stock-picking mutual funds, which had outflows of $1.8 trillion over the past five years. Passive equity vehicles now hold roughly $13 trillion in assets and own about 13% of the entire US stock market, including more than 20% of the S&P 500, fueling concerns that their steady inflows might distort markets by artificially pushing up stock prices and fueling volatility. Yet our analysis found no meaningful evidence of this. Furthermore, we believe passive’s influence in the US market may have peaked; though Vanguard, BlackRock and other indexed providers will continue to take in cash, active and quasi-active ETFs from JPMorgan and smaller issuers are poised to grow much faster.

Key research takeaways

• Passive Ownership Doesn’t Affect Performance: Contrary to concerns about inflated share prices, we found that stocks with lower passive ownership performed better long term than those favored by indexed strategies. Passive’s preferred S&P 500 stocks also had similar volatility to less-owned ones and an average valuation in line with the index at about 25x price-to-earnings.
• Active Lags Even Amid Low Passive Ownership: Regardless of whether a global region has a high or low allocation to passive strategies, roughly 80% or more of active equity fund managers trail their benchmarks long term, indicating that the level of passive ownership likely isn’t driving underperformance.
• `Passive’ Isn’t Always Passive: Passive fund assets exceed actively managed, but the number overstates the impact, since a significant amount of the former are in quasi-active strategies. Even some passive indexes, including the S&P 500, have active characteristics, such as an asset threshold or a selection committee.
• Nvidia’s Eye Test: As a member of the S&P 500 since 2001, Nvidia’s recent ascent to one of the world’s most held stocks, while dramatically outperforming the index, shows that active stock pickers and managers are still in control of price direction.

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