Passives surge

Half a decade on from being labelled as “worse than Marxism” by Alliance Bernstein analyst Inigo Fraser-Jenkins, passives have overtaken active assets in US-listed equities and look set to eclipse the entire industry by 2026, however, are peak passive concerns something investors should be worried about? 

The research note, boldly titled The Silent Road to Serfdom: Why Passive Investing Is Worse Than Marxism, created quite a stir among the asset management community and prompted a backlash from the ETF industry, whose assets predominantly sit in passive vehicles. 

Not that anyone needs reminding but the research from Fraser-Jenkins and his team warned about the threat of passive investing if it continued on its meteoric rise. 

He claimed a capitalist society dominated by passives would be worse than a Marxist one because at least communists attempt to allocate capital efficiently. 

“A given investment in active may or may not be the best decision for an individual investor but for the system overall there is a benefit in the efficient allocation of capital,” the research note stressed. 

Efficiency debate

At the time of the research note, the ETF industry totalled $2.4trn assets under management (AUM). This number has now surpassed $10trn. Bloomberg Intelligence analyst James Seyffart has forecasted passives will overtake active in the US by 2026, driven by its 2.3 percentage point annual growth of market share. 

However, in a research note, analysts at UBS warned the market is heading to an equilibrium which would create more opportunities for active managers. 

“Because passive funds are price-takers, any flows into passive products tend to exacerbate any mispriced equities. As a result, we believe we are close to achieving equilibrium in terms of passive penetration in the US equity market.” 

While it is easy to accept that markets would be inefficient if everyone invested passively in the same index, the wide variety of indices that employ different rules means they do not track the same underlying companies. 

Furthermore, even in the unlikely scenario where just 1% of the US market was active, assets would still total approximately $130bn, more than enough to ensure market efficiency. 

The future of active management

There is no doubt the rise of indexing has been a huge win for consumers. Index funds and ETFs have led to the democratisation of investing, where consumers can access areas of the market that were previously unavailable to them. 

There will always be room for active management in some areas of the market. However, it is unlikely passives will impact the efficiency of the US market – or any other for that matter – until ownership reaches single percentage point figures. And even then, it is not clear cut.