The rise and rise of passive investing

There are more passively managed assets than actively managed – what could this mean?
The Green Line
Duncan MacInnes
Investment Director

Soon, for the first time ever, there will be more money managed passively than actively in the US. The rest of the world is not far behind.

A cynic might describe passive investing as ‘unthinking’, while adherents might prefer ‘rules-based’ or ‘low-cost’. Regardless, we are crossing a Rubicon. We will politely ignore the irony that every passive investment begins with an active decision as to which index or asset class one would like to passively mimic.

The primary assumption of passive investing is that markets efficiently assimilate all relevant information instantaneously and reflect it in share prices. Effectively, the wisdom of crowds ensures it is near impossible to consistently beat the market, particularly after frictional costs and fees.

What often goes unsaid is that passive investors piggyback off active investors. Their success relies upon active investors constantly assessing and re-pricing risks, with the cumulative ‘best guess’ of all participants accurately and quickly reflected in prices. Active investors’ efforts to capture mispricing are the reason why markets are efficient.

If active investors cease to be rewarded for their efforts by excess returns or management fees then who ensures prices and fundamentals do not diverge? Is there a limit as to how large passives can be before markets become inefficient?

Furthermore, most indices are market capitalisation weighted, giving larger companies chunkier benchmark weightings. This has many consequences: passive funds can be surprisingly concentrated around big stocks, and passive investors may find themselves focused in the fully grown, most mature companies.

Most perversely the passive investor is by definition forced to buy the mania – the more overvalued a company, the larger it will be as a proportion of the index.

A stark example of passive investing leading lambs to the slaughter was UK banks exceeding 20% of the index just before the financial crisis. At Ruffer we eschew benchmarks, and this afforded us the flexibility to own no UK banks in the lead up to the crisis, thereby saving our investors from significant losses. Today, it is technology stocks (eg Google and Amazon) which dominate the S&P, and once again we are happy to avoid them.

Ruffer linkedin
Share on LinkedIn
Ruffer linkedin
Print to PDF
Damned if they do… damned if they don’t
June 2018: Wage inflation in the US poses a growing problem for the Fed
Quantitative tightening – what might it mean?
May 2018: Shrinking central bank balance sheets could undermine record asset prices
Why traditional safe havens might not work
April 2018: In the market sell-off this February, defensive assets failed to defend.

Chart source: EPFR Global, Bernstein

our thinking
Investment Review
July 2021: We have been talking of inflation for well over a decade – which is not the same thing as calling its timing. An impasse was created by the failure of the economy to grow after the 2008 crisis – all the risks (as we patiently explained) were deflationary, and in vain did the central banks and governments try to force an inflationary impulse into a sluggish world.
Audio icon
Bitcoin – the future arrived early
July 2021: The best investments are often the least comfortable ones. This is certainly the case with our decision to add bitcoin exposure to our portfolios in November last year.
Responsible Investment Report
In our latest quarterly report, Investment Manager Rory Goodman examines the global significance of US President Joe Biden's new emission reduction targets announced at the Earth Day summit, and we share our stewardship and engagement activities during the second quarter of 2021.
Navigating information
It’s easy to be overwhelmed by the volume of information aimed at us. Inundated by a daily torrent of headlines, images, messages and data, we can be left feeling unable to process it to a satisfying degree. For investors, navigating information is central to being effective. Insights from information theory and gauge theory can help.
80 Victoria Street
London SW1E 5JL
31 Charlotte Square
Edinburgh EH2 4ET
103 boulevard Haussmann
75008 Paris, France