Has indexing changed the market? The debate continues as exchange-traded funds continue to gather fresh cash. Assets invested in exchange-traded products hit a new record of $4.17 trillion through the end of June, according to ETFGI.
To put in perspective, an estimated 14.4% of the S&P 500 in terms by market cap or about $3.3 trillion is held passively, according to Macro Risk Advisors. The firm analyzed ETFs and indexed mutual funds or any fund with “index” on the label to determine passive ownership of S&P stocks.
“That amount is spread roughly equally between ETFs and index mutual funds,” wrote Pravit Chintawongvanich, MRA’s head derivatives strategist. “The $22 trillion market cap of S&P is 80% of the US total equity market capitalization, so assuming that 14.4% number is about the same for the rest, we can assume approximately $4.1 trillion of US equities are help passively.” The top 10 indexed funds (both mutual and exchange-traded) command 6.3% of total U.S. stock market cap and that share has more than tripled since 2003.
However, the rise of passive investing does not appear to have had an impact on realized volatility at all. Chintawongvanich found:
One would think that the more of the market is held passively, the higher correlation we would see (and thus potentially, higher index volatility). But with stock correlations at all-time lows while passive ownership is at an all-time high, that doesn’t seem to be the case.
We could also look at volatility on a single stock level, and see if passive ownership is affecting it. We scatter plotted S&P 500 stocks, using % passive ownership on the X axis and 6-month realized volatility on the Y axis. We see no effect. We also took a look at dividend yield vs. % passive ownership. This isn’t very convincing either, although we do note that none of the very highly passively owned stocks (>25%) have a div yield much below 3%.
Finally, we looked at passive ownership vs. P/E ratio, trying to see if high passive ownership inflated valuations. We don’t see any convincing relationship here either.