A Potential Passive Investing Bubble: High Active Share Investing

July 2018 | Public Version

Key Takeaways

  • Billions of dollars are flowing into passive funds and out of actively managed funds.
  • 10 stocks are contributing 116% to the S&P 500 TR Index return while the remaining are contributing -16%, as of 6/30/2018.
  • History may not repeat, but it rhymes.Investors should be concerned about exposure to FAANG stocks.
  • Historically, investing in high-conviction, high-active share funds has resulted in decreased portfolio volatility and outperformance relative to benchmarks.

Billionaire investor Carl Icahn recently called passive investing a potential bubble that “[may] implode and could lead to a crisis bigger than 2009.” Icahn explained that investors are making a mistake using the market as a casino, with too much money flowing into index funds and investors not knowing what they own.

So how did we get into a potential passive investing bubble?

With interest rates held exceptionally low for a prolonged period, artificially expensive bonds made stocks appear relatively inexpensive. Additionally, the race to the bottom for fund fees caused some investors to overlook net return potential for the lowest fees. These circumstances resulted in massive inflows into equities as an asset class via passive index funds, with the rising tide lifting all stocks and passive investing becoming a self-reinforcing cycle. In the event of market turmoil, investors with heavy exposure to certain stocks may experience significant losses. We believe that investors should consider moving into actively managed funds in an attempt to mitigate the potential burst of what may be the passive investing bubble.

Flows into passive funds have grown by 25% annualized since 2011, culminating in $692 billion flowing into passive funds in 2017.

The Creation of a Potential Passive Bubble: U.S. Fund Flows ($ Billions) into Active and Passive Funds Since 2006

Source: Morningstar Direct. Inflows based on flow of U.S. money into passive and active funds between 2006 and 2017.

Past performance is no guarantee of future results. The referenced indices are shown for general market comparisons and are not meant to represent any fund. Investors cannot directly invest in an index; unmanaged index returns do not reflect any fees, expenses or sales charges.


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