2024-07-08 13:00:00 ET
Summary
- We attempt to answer a number of questions we have gotten from clients about the impacts that rising levels of passive investing may have had on the stock market.
- While it is extremely difficult to make conclusive statements about the impact of passive investing, we use our understanding of how stock markets and investors behave to reach some reasonable tentative conclusions.
- If passive investing helped push up the prices for mega-caps or push down the prices for other stocks in a way that was not justified by their underlying fundamentals, future returns will be better for the undervalued stocks and worse for the overvalued ones.
Executive Summary
In this piece, we attempt to answer a number of questions we have gotten from clients about the impacts that rising levels of passive investing may have had on the stock market. While it is extremely difficult to make conclusive statements about the impact of passive investing, we use our understanding of how stock markets and investors behave to reach some reasonable tentative conclusions. It seems plausible that the increasing share of passive investing might have helped intensify a few features of today's markets - notably the rise of the mega-cap stocks and the underperformance of value and small caps. But any effect was likely quite small, and passive investing cannot change the basic math of investing in the long run. If passive investing helped push up the prices for mega-caps or push down the prices for other stocks in a way that was not justified by their underlying fundamentals, future returns will be better for the undervalued stocks and worse for the overvalued ones.
Introduction
This has been one of the hardest quarterlies to write that we can remember. 1 One way you can tell is the fact that it is late, even by our pretty relaxed standards of when in a quarter a quarterly letter should come out. For many quarterlies, much of the pain comes during the blank sheet stage of the writing process, when brainstorming what to talk about. In this case, we already had our topic - indeed, we had promised in our last letter that we would talk about the impact of passive investing on the market in our next piece....
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For further details see:
GMO Q2 2024 Quarterly Letter