UBS: Addressing the passive bubble concern

George Geddes

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Passive investing has exploded in popularity over the last decade, pulling in a significant volume of assets but this growth in adoption is not without its skeptics.

The most recent investor to bash the industry is famed hedge fund manager Michael Burry, who bet against the subprime crisis in the US. He claims passive investing is in a bubble but is he correct?

In a recent report, UBS argues ETFs are just an investment wrapper and do not cure the liquidity risks of an underlying market.

Named “Whack-a-mole: Addressing the ‘passive bubble’ concern”, the report offers the firm’s counterargument against these fears of passive investing causing the next financial crisis.

UBS believes criticism of passive investing usually comes from a biased source, namely active managers and therefore, comes little evidence to support these claims.

One issue raised by Burry is the price distortion in the underlying market made by the passive bubble, however, UBS argues that even though ETFs may be growing in popularity, they still own a relatively small market share with respect to active.

ETF Insight: What do ETF outflows say about bubble fears?

Additionally, roughly 80% of ETF trading takes place on an exchange, meaning only 20% of ETF trading results in trades in the underlying market.

In comparison, active investors own more of the market, trade more frequently and trade based on the view of the individual securities, according to UBS.

ETFs and index funds are not the only investment vehicles that have grown in popularity. In tandem, hedge funds have consistently gained assets since the financial crisis, reaching $3trn, but has not raised any concerns while passive has.

While liquidity is the biggest concern for active managers, UBS says volatility in the underlying market will not be isolated to ETF investors but more so to mutual fund holders, individual securities and other investment vehicles.

When liquidity becomes an issue for ETF buyers, this is reflected in the price of the ETF the same way it is reflected in the price of an individual security.

Therefore, it is down to the investor to carry out their due diligence to be aware of the liquidity risks of a market before making any investment decision.

UBS believes ETFs have improved the efficiency accessibility for investors. The growth of ETFs has reduced the costs of investing, improved tax efficiency, increased access to various markets and has made it easier to construct and manage diversified portfolios.

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