Odd Lots Why The Rise of Passive Investing Might Be Distorting The Market
Feb 10, 2020
Mike Green, Chief Strategist at Logica Capital Investors, discusses the explosive rise of passive investing and its unintended consequences. He highlights how money flowing into index funds distorts market dynamics, affecting price discovery and liquidity. Green critically examines the FIRE movement, questioning the sustainability of these investment strategies amid shifting market conditions. He also delves into the implications of algorithm-driven investing and the influence of regulatory changes, sparking a debate on the balance between active and passive management.
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Benchmark Distortion
- Passive flows create a performance advantage for indexed securities, similar to a carnival game where focusing on one horse creates a perception of outperformance.
- This distorts benchmarks, making active managers appear underperforming when the measurement itself is flawed.
Declining Alpha
- The declining alpha of strategies like the buy-write index, which should deliver consistent returns, points to market distortion.
- Traditional alpha calculations, based on efficient market hypothesis, fail to capture the distorted market dynamics.
Poker Analogy
- Michael Mobison compares the passive investing trend to the online poker boom where bad players left, making it harder for professionals.
- Mike Green argues that this analogy is flawed because markets, unlike poker, aren't ergodic systems with fixed probabilities.