A Reuters article today made the rounds this morning on ETF ownership of S&P 500 stocks that was an object lesson in social media gone wild. The first I time read the article was on CNBC’s website. The article is confusing, which is why it got so wildly overwrought on Twitter. Here’s the first paragraph:
“Higher single-stock volatility, valuation distortions and liquidity concerns could grow due to the surge in popularity of exchange-traded funds (ETFs), which now account for more than a third of U.S. ownership of the S&P 500, Bank of America/Merrill Lynch (BofA/ML) said.”
This is citing a Merrill Lynch study I haven’t got my hands on yet, but taken by itself, it’s, of course, absurd. The market capitalization of the S&P 500 is roughly $22 trillion as I write this. The entire ETF market in the U.S. is $3 trillion. That’s 14%. Even the whole industry—about $4 trillion, would only be 18%.
Doesn’t Add Up
And of course, that’s a ludicrous overstatement. By my count, there are 424 ETFs tracking U.S. equities. The assets across all of these funds are $1.47 trillion.
So even if all of those funds were just in S&P 500 stocks, it would be about 6.5%. Of course, there are loads of small-cap funds in that list, as well as a bunch of actively managed funds, and so on.
If you limit it just to the funds targeting either large-cap or total market, you end up with about 174 funds (depending on whether you include things like dividend ETFs and growth and value funds, which I did), or about $917 billion in assets under management. That’s about 4% for those of you playing the home game.
So, obviously, this is just wrong. However, the second paragraph of the article contradicts the first anyway:
“The proportion of stocks on the main U.S. benchmark equity index now managed passively has nearly doubled since the 2008 crisis to 37 percent while ETF trading accounts for about a quarter of the daily volume across U.S. exchanges, BofA/ML said.”
Not Just ETFs
OK, so now we’re not talking about ETFs, we’re talking about all passively managed assets in the world. This is impossible to figure to actually calculate (trust me, I’ve tried), but you can get close. In fact, BofA/Merrill Lynch just published a study in May on this topic, and its conclusion was that 26% of all managed funds were index-based; however, 38% of funds chasing U.S. equities were passively based:
So if 38% of the fund industry is passive, what’s the rest? Active. From the May report: “Today, there is $7T in U.S. active equity AUM (vs. $3T in 2000), ~4,500 active equity funds, and ~750 active equity managers, by far the most saturated market. Bottom line, there is too much capacity in the industry … ”
I suspect this is what’s really being regurgitated here.
The Rest Of The Story
So what about the hyperbole here, that the capital markets will cease to function because enormous swaths of companies are owned by passive players?
Reduced to the absurd extreme—every single investor dollar is passive—of course nothing functions. This is roughly the logical equivalent to saying “what if every single house insured by Aetna caught fire tonight?”
So how much do various index firms own of the S&P 500? Well, the only clean way to answer that is to troll every 13-F filling for every index-based fund and ETF in the U.S., then guesstimate against that for the non-U.S. market, which, I admit, I did not have time to do.
It’s easy to do it for some marquee names, however. Here’s Apple:
You can just look at the big three index players that own about 16.5% of Apple’s float. You get similar numbers for Exxon or Disney or any other large-cap U.S. stock. But note who else is on this list: Berkshire, American Funds (Capital Group) and Fidelity.
Active management isn’t somehow not getting to participate here; far from it. Most of the S&P 500 stocks are all over the holdings lists for active managers, everywhere in the world. Hence the fact that 66% of Apple’s entire float can be accounted for by Bloomberg. As a class, active investors hold far, far more sway than a handful of index fund managers, which is why the stock market continues to go up and down every day.
Every time this “index ETFs eat the world” meme shows up, I generally have to say the same few things:
- Yes, indexes and ETFs are a big deal, but it’s because they continue to deliver better returns for investors than far-more-than-half of the actively managed alternatives.
- Yes, ETFs trade a lot (roughly 25% of the value of the U.S. exchanges every day); however, this is dwarfed by derivatives trading. For context, the e-Mini S&P 500 future contract generally trades 10 times as much as SPY, which is the most liquid equity security in the world.
- I believe in free markets. When I look at the stock market, I don’t really see one bereft of innovation, where companies aren’t being rewarded for their good performance and punished for being dumb. The S&P 500 is up 9.79% this year so far. But Activision Blizzard is up 60%, and Signet Jewelers is down 30%. I just don’t buy that ATVI is being “held back” by its passive owners, while at the same time, SIG is being “propped up” by the constant new flows into the S&P 500. To my eyes, the markets seem to be doing a good job of sorting out the superstars from the dogs.
But even if you think there’s a real problem, nobody’s ever given me the answer to this: What’s your proposed solution? Are you going to ban the index fund as a vehicle? How’s that going to work, exactly? People will just stop licensing indexes and closet-index. I mean heck, they’ve been doing that for years already. Are you going to force 401(k) plans to only use active funds, guaranteeing a generation of poorer retirees?
Good luck getting that one through the SEC.
At the time of writing, the author held no positions in the securities mentioned. Contact Dave Nadig at [email protected].