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The Shift from Active to Passive Investing

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The Shift from Active to Passive Investing

Potential Risks to Financial Stability?

Federal Reserve Bank of Boston,

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A major move toward passive investment management has implications for financial stability.

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Editorial Rating

8

Qualities

  • Analytical
  • Innovative
  • For Experts

Recommendation

Passive asset management has profound implications for global financial stability, according to this scholarly study from Federal Reserve researchers Kenechukwu Anadu, Mathias Kruttli, Patrick McCabe, Emilio Osambela and Chae Hee Shin. They isolate the impacts passive funds could have on liquidity transformation, volatility and asset valuation, and find that these developments bear importantly on risk management. Retail and institutional investors, as well as risk professionals, investment managers and regulators, will find this a worthwhile read.

Summary

Passive investing has grown faster than active management since the 1990s. Whereas active management seeks to outperform a benchmark, the passive approach tracks an index’s results. In 1995, passive mutual funds (MFs) and exchange-traded funds (ETFs) amounted to a mere 5% of both equity and bond assets under management. By the end of 2017, their shares had risen to 45% for stocks and 26% for bonds, respectively. Several forces are driving this transition: The advent of stock index MFs in the retail marketplace have helped, as have passive investing’s reduced costs and active managers’ underperformance. The increasing prominence...

About the Authors

Kenechukwu Anadu is an analyst at the Federal Reserve Bank of Boston. Mathias Kruttli et al. are economists with the Board of Governors of the Federal Reserve System.

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