Odd Lots Why The Rise of Passive Investing Might Be Distorting The Market
Feb 10, 2020
Mike Green, Chief Strategist at Logica Capital Investors, discusses the explosive rise of passive investing and its unintended consequences. He highlights how money flowing into index funds distorts market dynamics, affecting price discovery and liquidity. Green critically examines the FIRE movement, questioning the sustainability of these investment strategies amid shifting market conditions. He also delves into the implications of algorithm-driven investing and the influence of regulatory changes, sparking a debate on the balance between active and passive management.
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Flawed Passive Narrative
- Passive investing's outperformance narrative, based on Bill Sharpe's work, assumes passive investors hold all securities without transacting.
- This assumption is flawed as passive funds constantly transact, influencing the market and thus distorting the active vs. passive comparison.
Benchmark Distortion
- Passive flows create a performance advantage for indexed securities, similar to a carnival game where focusing on one horse creates a perception of outperformance.
- This distorts benchmarks, making active managers appear underperforming when the measurement itself is flawed.
Declining Alpha
- The declining alpha of strategies like the buy-write index, which should deliver consistent returns, points to market distortion.
- Traditional alpha calculations, based on efficient market hypothesis, fail to capture the distorted market dynamics.