The implications of passive ownership has been a hot topic this year with the likes of Elon Musk, Bernie Saunders and Berkshire Hathaway’s Charlie Munger wading into the discussion, however, it could become an increasing focus for regulators after research warned ownership levels are even higher than previously thought.
According to the recent academic research, titled The Passive-Ownership Share is Double What You Think It Is, passive ownership of the US stock market was “at least” 37.8% in 2020, instead of the previous estimate of 15% from the Investment Company Institute (ICI) which only accounts for index funds and ETFs.
From studying end-of-day trading volumes on rebalancing dates, authors Alex Chinco and Marco Sammon reach this 37.8% estimate by incorporating institutional investors such as pension funds that directly invest in the weights of indices such as the Russell 1000 or S&P 500.
Passive ownership is a concern that has genuine merit. The majority of index fund and ETF assets in the US lie in the control of the ‘Big Three’ – BlackRock, Vanguard and State Street Global Advisors – which could create future corporate governance issues.
Three asset managers will end up with control of the majority of votes for every public company in the US and across the globe while academic research has found having the same major shareholders can create anti-competition issues.
“The rise of passive investing has been one of the most talked about developments in financial markets,” the research said. “The size of this blind spot poses a real problem for anyone trying to use these models to make policy decisions.
“Financial economists should care about the percentage of the US stock market that is owned by passive investors for the same reasons that rain forest ecologists care about the relative biomass of insects in the canopy.”
From a trading perspective, with 37.8% of investors in the Russell 1000, Russell 2000 and S&P 500 rebalancing at the same time, this can drive the short-term performance of the underlying companies.
“These numbers imply that index inclusion is the single most important consideration when modelling portfolio holdings,” the research added.
Furthermore, the authors stressed their estimate could be “too low” due to the fact they only focus on trading volumes at market close when many passive investors do not always trade at the end of the day.
Highlighting this, earlier this year, David Hsu, senior equity product specialist at Vanguard, told ETF Stream ETF portfolio managers can optimise rebalances by spreading the trades over a number of days before and after the rebalance date.
As Hsu said: “ETF portfolio managers have become smarter. When a trade becomes overcrowded, a passive manager can hold off buying a stock until after the rebalance date which reduces market impact and keeps costs low.”
With passive ownership at higher levels than previously anticipated, the implication for underlying companies becomes even more significant and one regulators will be keeping a close eye on in the coming years.