The huge wall of money flowing into passives is being driven by the complacency of investors who are trying to buy everything, says Andy Merricks, head of investments at Skerritts Wealth Management.
While concerns around a passive bubble have been well documented, Merricks says they are unwarranted as the bulk of money going into passive is recycled cash from active strategies.
“There is almost an exact mirror image of the funds flowing into passives to that of funds flowing out of actives,” Merricks says. “One type of fund is simply replacing the other as the vehicle of choice for people with money to invest. The growth in valuations, it can be argued, is therefore justified because the valuations reflect the state of the global economies rather than pure weight of money hitting equity markets. After all, in a successful capitalist world, one should expect the price of shares to keep hitting new highs.”
However, Merricks says that we could be seeing a bubble in complacency as investors shift from choosing their investments to deciding to invest in everything. “That is what a passive fund is,” Merricks says, “a cheap vehicle to invest in everything within the index that it is replicating.”
While Merricks maintains he is style agnostic, he says the shift to passive is reminiscent of the growth in passives in the 1990s bull market, which ended “spectacularly” in 2000.
“When markets do nothing but go up, why not invest in everything? Does it make sense to invest in failing companies? Not really, but momentum can mask the negatives…But what happens when the direction changes and valuations come down and stay down for a prolonged period as in 2000-2003? We would argue that you would be very keen to choose what you invested in rather than just sitting in a destroyer of value.”
Merricks remains bullish on the current state of global economies but warns that the bull market will end at some point, prompting a “major reversal” in the shift to passive.
“Those active managers that remain will be major beneficiaries of the recycled capital from the ‘buy everything’ brigade. Until that time arrives though, let the complacency reign.”