The rise of passive investing is making markets “less efficient and more fragile”, says Tom Stevenson in The Telegraph. Somewhere between a third and half of equity assets under management are now passive, meaning they are held by funds seeking to track market indexes without trying to beat them. Passive investing offers lower fund manager fees than the active variety.
The problem? Too much passive investing makes for less discerning capital allocation, with money blindly pouring into markets according to “fund flows” and “weightings”. Share prices are thus prone to becoming disconnected from reality – although more inefficient markets do at least open the way for active stock pickers to spot mispricing opportunities and scoop up bargains.
Are ETFs following?
A new generation of actively managed exchange-traded funds (ETFs) is trying to do just that, says The Economist. Inflows into “active” ETFs have surged from less than $5 billion in 2019 to over $100 billion last year. Investors should be wary. ETFs have revolutionised markets.
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But active ETFs are undoing that progress, charging high fees in exchange for complicated promises of “volatility protection”, or exposure to illiquid assets in private equity and debt. They are usually a “rip-off”. Another popular trend is “thematic” ETFs, which let investors play everything from pet care to Chinese cloud computing, says James Mackintosh in The Wall Street Journal. But the approach is failing.
Artificial intelligence (AI) has dominated markets for most of this year, yet AI-themed ETFs have actually underperformed the US and global stock benchmarks (you would have done better by just buying Nvidia). Three AI ETFs even managed to shed value in 2024 – picking the right theme at the right time and still losing money must be “galling”.
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