Active vs Passive Investing

This chart shared by 361 capital highlighting the the flow of money out of active investing into passive investing products caught my attention:

The trend has now created observable developments and strains across the investment landscape. Here is 361 Capital’s piece on those changes. The main findings:

This large stock premium phenomenon is not consistent with long-term risk and return expectations and suggests that a ‘free lunch’ has been available by purchasing large mega-cap stocks (higher returns with lower risks). This flocking by many investors into passive and index-related strategies is not without consequence, however.

Valuation distortions are normally the result of abnormal asset flows. Over the past quarters and years, we have begun to observe potential valuation factor bubbles that would be consistent with immense asset flows into passive vehicles noted above.


Clearly, something significant has shifted in the valuation of capitalization. Large companies have performed exceedingly well, and their valuation has reached historic and extreme levels. We believe this previously unseen level of valuation has been driven by the hundreds of billions of investor dollars that have flowed into relatively unmanaged and price-insensitive passive vehicles. Ironically, this flood of dollars into passive vehicles improves the performance of index-related portfolios, creates stronger performance headwinds for the remaining active managers, and in-turn, draws more investors into passive investing.

At some point, the valuation imbalances being created by millions of investors blindly herding into unmanaged index funds will be corrected by market forces. We only hope that the old adage proclaiming that the market can remain irrational longer than (active) investors can remain solvent does not apply in this case.

Investing is not easy and the passive trend made has made investing very simple and neat for millions of people all these years. I have no idea when things will get messy but they always do.