London – New data shows passive funds’ average stake in S&P 500 constituents has doubled in just seven years – a sign of just how much the index investing thesis has resonated with investors across the world.
According to Bloomberg Intelligence, the average company in the S&P 500 had around 21.2% of its stock owned by passive vehicles such as index-tracking ETFs and mutual funds by the end of March. Even on a weighted average basis, passives are said to own an average stake of 18.6% in US large-cap names.
Source: Bloomberg Intelligence
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This trend chimes with separate data from the Investment Company Institute, which suggested passive ownership of all Wall Street stocks doubled over the past ten years. Meanwhile, the share of the US stock market owned by active funds fell from 20% to 14% over the same period, the report said.
Naturally, this trajectory has not occurred without reason. The idea of buying the market – or a stylised slice of a market – at low cost and capturing diversified and rules-based exposures is an appealing prospect that serves at least some role in most investors’ portfolios.
Also, S&P Dow Jones Indices’ most recent SPIVA Europe scorecard shows 94.9% and 94.7% of euro and sterling US equity funds were outperformed by the S&P 500 over the 10 years to the end of 2021, so it should be little wonder investors have been happy to accept benchmark returns when most active candidates have struggled to outperform over longer periods.
The parsimonious case for ‘buying the market’ and the impressive returns of the past 10 years may be too good to last in the long term, however, while history tells us free lunches are rare and often have an expiry date.
Back in 2019 when ETF assets were just half of what they are today, Scion Capital and ‘Big Short’ investor Michael Burry told Bloomberg the growth of ETFs reminded him of the bubble in synthetic asset-backed collateralised debt obligations (CDO) prior to the Global Financial Crash of 2008, because price-setting is driven by massive capital flows rather than fundamental security-level analysis.
Supporting the case that passives create inefficient markets, recent research from the Universities of California and Minnesota argued stock market elasticity – how reactive share prices are to supply and demand – fell by -35% between 2004 and 2016, with the rise of passive investing alone accounting for a 15% decline.
The market-moving power of indices was also illustrated in another study by the Universities of California and Stavanger this year, which reflected on past research showing between 1976 and 1983, stocks gained an average of 2.8% on the day their inclusion in the S&P 500 was announced. Another reported stocks included in the S&P 500 bounced 3.1% the day after their entry was announced between 1989 and 1994.