Lesson Learned in Trenches of a Passive Stock Market: Don't Sell

Traders, Markets Brace for Fed and Tax Turbulence

Active investors have found an unlikely ally: passive funds.

That’s according to Chris Harvey, head of equity strategy at Wells Fargo, who says there are signs fundamental active managers are learning to coexist with the enemy by doing as they do: holding on at all costs. “The buy-side is quickly adapting to -- and in some cases seems to be arb-ing -- these passive flows,” he wrote in a note first published Sunday. “From an odd angle, it looks like passive is actually helping active.”

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It’s a contrarian take on how the market may evolve as money keeps pouring into index and exchange-traded funds, giving passive strategies as much as 35 percent of mutual funds’ stock investments. Assets put into exchange-traded funds have surged over the last decade -- from about $400 billion 10 years ago to about $2.9 trillion today.

Harvey’s evidence is the improving performance of active funds versus indexes, with more managers beating their benchmarks in 2017 than any year since 2009. According to his theory, after living through years in which every impulse to sell was regretted, managers have “decided to altogether stop, or dramatically slow, their selling and it’s worked -- relative performance continues to improve,” he said. It’s “morphed into a seller’s strike,” he wrote.

Active investors may also be picking up on momentum -- a factor investing strategy which tracks the market’s best performing stocks -- as they pour more money per every dollar of passive into tech purchases than they did at the year’s start. Further, active managers may be able to demand a higher price for trades. An increase in passive points to “less natural sellers,” so the active traders who do decide to sell could ask for a higher premium on the liquidity they create, Harvey said.

“The move to passive equity investing has accelerated in recent years but without too much thought to the knock-on effects,” he said. “Today, we’re beginning to see how Passive equity flows are changing the investing landscape for the good and the bad.”

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