By now it has become common knowledge that in the ongoing war of attrition between expensive – but very much underperforming under central planning – active investing and cheap and efficient passive, ETFs, the former are winning and the latter will likely concede majority control in just over a year.
Furthermore, as BofA notes, US trading volume (as of late summer 2016) was 24% exchange traded funds (ETFs) and 76% single stocks versus 20% ETFs and 80% single stocks three years ago. By now ETFs are likely responsible for 30% of trading volume or much more.
However, it is far less known that as “active” loses market share, “passive” has become a giant force in the overall market, and as of 2016, the percentage of S&P 500 market cap held by Vanguard alone has doubled since 2010. At this rate, ETF-giant Vanguard alone will own 10% of the entire market by the end of the decade.
Unfortunately, this unprecedented dominance by investment vehicles that merely reflect flows and not fundamentals, means that the market is becoming increasingly fragile, inefficient and broken, something which can be seen in the excess volatility (measured by both standard deviation & price declines) of stocks with a larger proportion of shares held by passive investors.
Yet while in the US ETFs are yet to dominate the market, resulting in even greater systemic fragility and irrationality, this is already the case in Japan, which like with QE and NIRP, has been the guinea pig for countless monetary and market experiments.
Just like in the US, there is a tangible reason why the flows into Japan passive investing have been massive: active managers suffered outperformance rates 12ppt lower between 2014-2016, a period in which passive inflows were accelerating vs. over the prior decade (34% of funds outperforming the TOPIX between 2014-2016 vs. 46% outperforming between 2002-2013).
As a result, in Japan passive funds are now two-thirds of total….
… with the flow differential between active and passive absolutely staggering.
It is unclear how much of this has been the result of BOJ intervention, but what we do know is that over the past 5 years the Japanese central bank has been purchasing massive amounts of equity ETFs in its attempt to control the stock market, and at last check the BOJ owned 75% of total Japanese ETFs.
If Japan is indeed the harbinger of what is coming, then over the next 3-5 years, the Fed will become the biggest investor in the ETF market as the US central bank does everything in its power to avoid a terminal stock market collapse after the next depression.
Meanwhile, the trend in the US is clear: investors increasingly are giving up on single stocks, and thus fundamentals, and embracing the collective hive mind of ETFs…
… resulting in “less stock selection, more sector selection”, and an ominous increase in “long-term market inefficiencies” according to Bank of America…
via Zero Hedge http://ift.tt/2CVVHNG Tyler Durden