Research Results
Following is a summary of their findings:
- Passive funds participate more aggressively in stock-lending programs than active funds and other nonmutual fund lenders—lending shares to arbitrageurs (such as hedge funds) who are seeking to short the stock.
- Stocks with a high level of passive ownership exhibit greater supply of lendable shares, which results in larger short positions, lower lending fees and longer durations of security loans. The effects are both statistically and economically meaningful. For example, a 1 standard deviation increase in passive ownership is associated with an increase in a half-standard deviation in lending supply. And moving from the 25th percentile (1%) to the 75th percentile (10%) of the passive ownership results in 27 basis points lower lending fees.
- The effect of passive investors on security lending is significantly larger than the effect of other lenders, such as actively managed funds and other institutional asset managers.
- By limiting short-sale constraints, stocks with more passive ownership exhibit lower cross-serial correlations with negative market returns and less negative skewness in stock returns— price discovery conditional on negative information is faster for constrained stocks when passive ownership is higher.
The bottom line is that the shift to passive investing has generated a significantly greater supply of lendable stock, resulting in larger aggregate short positions, lower lending fees and longer security loan durations. The result is that short-sale constraints that allow mispricings to persist are relaxed—stocks can be borrowed more easily, at lower prices, and for longer time periods. By their actions, passive investors are making the market more efficient. Palia and Sokolinski concluded: “By making short-selling possible, passive investors can complement the information acquisition efforts of active investors who are willing to short-sell stocks. As a consequence, markets can exhibit faster price discovery by incorporating negative information into stock prices.”
They add that their “results cast doubt on the idea that passive investing only reduces the amount of information incorporated in prices and generates price inefficiencies. In fact, the relaxation of short-sale constraints leads to more information being embedded in securities prices.”
Summary
As sure as the sun rises in the east, the proponents of active management will continue to attack passive investing. The reason is simple: It threatens their livelihood. Thus, their behavior should not come as a surprise.
Larry Swedroe is the director of research for The BAM Alliance, a community of more than 130 independent registered investment advisors throughout the country.
