Flows into passive funds disproportionately raise the stock prices of the economy’s largest firms, and especially those large firms in high demand by noise traders. Because of this effect, the aggregate market can rise even when flows are entirely due to investors switching from active to passive strategies. Intuitively, passive flows increase the idiosyncratic risk of large firms in high demand, which discourages investors from correcting the flows’ effects on prices. Consistent with our theory, prices and idiosyncratic volatilities of the largest S&P500 firms rise the most following flows into that index
Our theory implies that passive investing reduces primarily the financing costs of the largest firms in the economy and makes the size distribution of firms more skewed.
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3256430 In this paper we examine the differences in aggregate ownership of stocks held by passive equity funds and active equity funds and in the characteristics of stocks held by these funds. We find that holdings of passive funds do not mirror the holdings of active funds. There are systematic differences in the holdings between the two groups with active funds more likely to hold smaller stocks, growth stocks, and stocks with higher momentum, higher turnover and more recent IPOs.
We find that the holdings of passive funds do not mirror the holdings of active funds. There are significant systematic differences in the holdings between the two groups with passive funds more likely to hold larger stocks, value stocks, and stocks with lower momentum and lower turnover, but less likely to hold positions in younger firms.
The S&P 500 has become an increasingly concentrated index over the past decade, with the top seven stocks now comprising 28% of the total, and the returns of those stocks far outpacing that of the average stock in the index. Active managers are systematically underweight the very largest stocks, and this is particularly true of concentrated high active share managers. If the purpose of a benchmark is to be a fair measuring stick to determine whether a manager has skill, a market capitalization-weighted index is not a good benchmark for most active managers, and this becomes increasingly true as the index becomes more concentrated. History suggests that the next decade is likely to see a reversal of the recent pattern with the capitalization-weighted version of the S&P 500 underperforming the equal-weighted version. In such an environment, active managers will suddenly look much better versus the S&P 500 and other capitalization-weighted benchmarks.
So perhaps what has worked in the past may not forecast future returns.
I think we have been reading this same prediction for a number of years.
The fact is that the S&P does rebalance - of a sort - over time. Companies are removed and added - just far less than an actively managed fund. No question, the concentration is higher now than it has ever been, but it is not uncommon for the top 10% to be over 1/4 of the S&P 500.
In fact, going back to the 1960s, the S&P 500 has tended to see stronger performance during periods where market concentration has been rising, according to a recent report from Michael Mauboussin, head of consilient research at Counterpoint Global, and Dan Callahan, vice president of Counterpoint.
Yep.
I went a little broader on that–VONE-Vanguard Russell 1000 ETF
Top 10 stocks =33%. But #9 is Berkshire Hathaway class B not a technology stock. So I subtract 1.7%. So the top 9,which are technology stocks, = 31.3%.
I see your link indicates the top 10% of the S&P 500 equals to 38%! WOW!
The ride up was fun. But if technology fall out of favor–Look Out Below!
I decided to check SPY [S&P 500] on Morningstar.
Top 10 36%. But again Berkshire Hathaway class B in in the top 10. Subject that holding out 36-1.75-34.24%
I didn’t understand everything the linked article said but, from a Macro or Bird’s Eye view, markets are complex systems that evolve in mysterious (unexpected?) ways. So perhaps what has worked in the past may not forecast future returns.
Yes, most likely not. But there are eternal truths. For example,
“You can’t go broke as long as you can pay your bills.”
“Most crashes are caused by excessive debt, 1929 and 2008 being prime examples.”
“Volatility is a feature not a bug. Buy only stocks that will bounce back.”
“Emotions have no place in investing. Master them, not an easy task.”
Perhaps being autistic is an advantage in investing.
Example: Michael Burry “The Big Short”
I remember a scene in that movie where a big investor in his hedge fund was screaming at him to give them their money back. But the investor had signed a contract allowing Burry to invest wherever he thought fit. Burry forsaw the real estate crash coming and invested accordingly, making huge profits for himself and his investors.
I didn’t see or read The Big Short. I read and reviewed The Greatest Trade Ever. John Paulson lived with a level of stress that I could not endure.
o o o o o o o o o o o o o o o o o o o o o o o o
Investing is the most difficult job I have ever tried, it is not really based on economics but on Animal Spirits (John Maynard Keynes), a game with no know rules. When I was young i enjoyed going to casinos, not for the gambling but for the entertainment. On a trip to the US I visited Las Vegas. In one of the casinos I found a booklet explaining all the games. When I became interested in options I realized that the seller played the role of the house while the buyer is the gambler. The secret is that the odds are stacked in favor of the house. While the comparison is far from perfect it is close enough. The interesting part is that selling covered calls is simpler than investing in stocks.
While I started selling calls the ‘standard’ way over time I changed my approach with the help of the Call Selector and lately the Call Roll Selector. There is way too much data in option chains to trade options effectively without such help.
Instead of WOW or GTA or one of those MMORPGs in which a player loses a pot of gold, or gets killed, then magically reincarnates…
Or finds a pot, or some magical power…
Adults at the Options MMORPG lose or gain real world coin.
