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Is There a Passive Investing Bubble?

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Is There a Passive Investing Bubble?

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Brian-

As more and more investors switch from actively picking stocks to passively investing in ETFs, asset managers and market experts worry about a passive investing bubble. Hedge fund expert Michael Burry claims the rush to invest in passive investments is unfairly affecting stock and bond prices and the outcome may be worse than we expect.

What is the Passive Investing Bubble?

It’s no secret there’s been an incredible rise in passive investments. With the large flow of capital into these investments, the underlying assets have artificially-inflated prices. There aren’t active investors actively picking the stocks – they are automatically picked by way of ETF and other passive investments.

Is this because investors don’t want to pick their investments or because they’ve lost faith in individual stock picks? No, but experts believe so. The passive investing bubble is largely due to an uptick in automated investment options (robo-advisors) and a shift of investor preferences, which happens with each new wave of investors.

What Could the Passive Investing Bubble Cause?

There’s truth in the matter that passive investing may cause problems. You have many more investors jumping on board, many of which aren’t looking both ways. They follow the masses and quite potentially, may invest in companies that otherwise aren’t worth the investment, but because the passive investments include it, that company’s stock becomes overvalued.

Technology doesn’t help the bubble either. Today, investors have instant gratification, buying or selling entire portfolios with the click of a button. Panic, fear, and the habits of the masses often influence what happens, which may inflate or deflate market securities unnecessarily.

Are Assets Getting Overpriced?

Here’s the fear – the passive investing bubble artificially inflates securities. What happens when everyone bails out of these packaged securities, whether six months or six years down the road? Experts, like Michael Burry, say ‘it’s going to be ugly.’ The overinflated prices will quickly crash, which could lead to another financial crisis that our economy doesn’t need at this point.

While it’s true many assets are overpriced, the assets most at risk are those with little popularity prior to the surge in passive investing. These investments don’t have the liquidity needed to undergo a major unfolding. Any assets with an unprecedented surge in investments thanks to passive investing may have the hardest time recovering.

The Bottom Line

Should you be worried about a passive investing bubble? You certainly shouldn’t let it drive your choices today. Honestly, if all investors act on a whim and unleash their passive investments at once, it would be a disaster, but how likely is that to happen? Most investors (at least should) be in it for the long-term. Acting on emotions leads to misinformation and rash investment decisions that don’t bode well. While the experts predict the worst, and it could happen, if everyone is aware of it and how to avoid it, then hopefully we can avoid the impending bubble and the majority of assets can retain their worth.

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