The US equity market is undergoing a dramatic but under-appreciated revolution, with the relentless rise of passive investing reshaping that's in the workings. This is a trend that many investors still need to get a better handle on. Because flows into index-trackers and an ETFs have continued at a remarkable rate this year. And it looks as though half of all US equity funds under management will be passive by early 2018.
While only about 14% of the overall US stock market is passively held, because much is own by founders, other companies, or big institutional shareholders. The impact is already becoming noticeable. Research published by Bank of America Merrill Lynch this week details some of the recent developments and their implications. In short, the analysts argue that the ETFisation of the S&P 500 is eroding the real liquidity of the market, leading to more crowding in certain areas and causing valuations to become distorted, and the shift is stark.
Vanguard alone now owns at least 5% stake in 491 stocks and the S&P 500 from 116 companies in 2010. It now holds almost 7% of the entire index. And underscoring the shift, Bank of America clients have bought $160 billion worth of ETFs and sold $200 billion worth of individual stocks just since 2009.
ETFs now account for 24% of all US equity market trading volumes, up from 20% three years ago. For traditional active fund managers the implications are grim. Most have expected to find more lucrative trading opportunities as the US stock market efficiency slowly arose with the rise of passive investors.
But in Japan, where nearly 70% of assets under management are passive, only 34% of active funds have outperformed the Topix since 2014 compared with 46% between 2002 and 2013. Now clearly ETFs are a tremendous boon to investors, giving millions cheap and easy access to financial markets directly, rather than through an expensive, rather often poorly performing intermediary. But it is also clear that this is not a costless this progression, given the apparent impact on the stock markets functioning.