The growth of passive investing shows no signs of letting up and neither do the warnings about it from people who earn their living actively managing investments.
In 2018, passive index funds reached 37% market share in the U.S., attracting $453 billion versus an outflow of $304 billion for actively managed funds, according to PWL’s Passive vs. Active Fund Monitor. Moody’s Investors Service expects passive funds in the U.S. to overtake actively managed ones by 2024.
In Canada, passive funds are also growing in popularity, albeit at a slower place, with a market share of 10.5% in 2018.
In recent months, there has been more warnings about the dangers of so much money pouring into passively managed investments. One of the most notable was from Michael Burry, the hedge fund manager featured in The Big Short, the book and movie about the financial crisis.
Burry, who famously bet against the U.S. housing market before the crash, claimed last month there’s a bubble in passive investing. Massive inflows into index funds and exchange traded funds (ETFs) are distorting prices for stocks and bonds in the same way as collateralized debt obligations distorted the subprime mortgage market in the mid-2000s, he told Bloomberg News.
Burry’s argues so much money held in passively managed investments is making markets less efficient and will amplify the damage when the market falls.
“The theatre gets more crowded, but the exit door is the same as it always was,” he says. “The longer it goes on, the worse the crash will be.”
That sounds pretty scary, but does it hold up to scrutiny? Barry Ritholtz, another high-profile U.S. money manager, doesn’t think so. He recently published an article titled Ignore the Fear-Mongering: Actively Managed Money Dwarfs Passive.
Ritholtz says concerns about passive investing taking over the investment world are nothing more than hype. By his calculation, actively managed equity investments still dominate passive by a margin of 8-to-1 in the U.S. and 15-to-1 worldwide. When fixed income is added in the margin increases to 60-to-1.
The difference in magnitude stems from Ritholtz’s inclusion of all investable money in the calculation—hedge funds, pension funds, foundations, etc.—not just mutual funds and ETFs. Passively managed investments are still a small fraction of the $82 trillion held in equities globally and $103 trillion in fixed income, he says.
Ritholtz maintains the surge in passive investing has been scary for one group—active managers, given the fees involved. Indeed, there’s a huge difference in the amount of fees charged by active managers versus passive managers. In 2018, the difference in Canada was 1.36% in favour of passive funds, representing net savings of $1.6 billion, according to the Passive vs. Active Fund Monitor, authored by PWL Research Director Raymond Kerzérho.
Ritholtz discloses that 60% of his firm’s assets are passively managed. At PWL Capital, we are proud to say the number is 100%. Investors are flocking to passive investments for the same reasons we’ve built our successful investing approach.
Low-fee funds that passively track the indexes allow us to efficiently capture market returns. Most active managers, by contrast, underperform the market, especially after those high fees.
Of course, you have to take negative returns with the positive, but there’s no reason to believe passive investing will make a market downturn worse. Backed up by a wealth of evidence, we’re confident passive investing is the best way to maximize your returns over the long term…despite those warnings from active managers.