A snowball called passive management

An analyst at the New York Stock Exchange last week.Nicole Pereira / getty

The complicated 2020 has reinforced some trends in the way of investing money.

Passive management, based on placing money at the risk of stock indices, fixed income or raw materials through exchange-traded funds (ETFs) or index funds lived a historical record last year: net inflows in ETFs (purchases less sales) of 756,000 million dollars (624,800 million euros), well above the 660,000 million of 2017.

These funds are dedicated to replicating the behavior of the indices and their success lies in that very thing, in moving as little as possible - below or above - from what the indicator does in a period of time.

To do this, they either buy all the assets of the index or use derivative products (futures, options) with which to replicate the index.

An objective that does not differ from that of active funds where managers choose specific bonds or stocks, and which will ultimately be judged on their ability to beat the index in the market they operate.

With data provided by the manager BlackRock, the total equity of the listed funds reached 7.86 trillion dollars at the end of last year.

And the largest exchange-traded fund in the world moves no less than 250,000 million dollars.

Currently, they represent slightly less than 30% of total investment funds when in 2008 they were 10%.

The advantages of this form of investment are quite evident: much lower commissions than actively managed funds and the possibility for the investor to diversify between companies, bond issues, and around the world if desired.

But its increasingly bulky volume opens up questions about how this way of investing can affect the markets and, therefore, liquidity, price formation, or the very efficiency of investments.

A study published by the National Securities Market Commission (CNMV) points out that ETFs can influence the risk profile, profitability, liquidity, correlation and information efficiency of the assets to which they are referenced.

Likewise, the authors of the work emphasize that "the concentration of operations in a reduced number of counterparties, managers or specialists can generate risks for the financial system in the event of defaults or coordinated actions by the main financial entities related to ETFs" .

Some dangers that refer to passive funds that use derivative structures, especially when they are not traded on official markets, but instead are agreed with a financial group.

Óscar Gil Flores, professor of the Master in Stock Market and Financial Markets at the Institute of Stock Market Studies (IEB), points to a certain homogeneity in the values ​​of an index.

“When investing is focused on replicating the positions of an index, this has a direct effect on the trading of its securities.

Consequently, movements in the market have much more amplified effects, since there is no diversification between assets, geographies and sectors, if they belong to a benchmark index with a lot of investment through indexed products ”, he explains.

A point of view not shared by Aitor Jauregui, head of the giant BlackRock for Spain, Portugal and Andorra.

Jauregui explains that active management funds have a world heritage of 32 trillion dollars, four times more than those linked to indices and, in addition, points out that for every dollar that is rotated in indexed management, 20 are moved in activates it.

To defend the small impact of indexed investment in the markets, the head of BlackRock pulls data: “The value of global equities is 70 trillion dollars, while that of the fixed income and debt market reaches 110 trillion of dollars.

However, the money of ETFs and indexes worldwide reaches 7.86 trillion dollars of which only two trillion are in fixed income and another five trillion in stocks.

This means that this type of management represents less than 2% of the value of the debt and fixed income markets, and 7% of the stock markets.

The impact on the market is therefore small ”, he indicates.

Impact on price

But the concern about the rise of these products stems from how they are structured and the products in which they invest.

Concern among market supervisors about exchange-traded funds is not so much due to the nature of ETFs but to the fact that they use complex structuring, lending and asset selection strategies that could create problems.

In this sense, the study published by the CNMV, and signed by Carlos Aparicio Roqueiro and Francisco Javier González Pueyo, explains that special attention deserves the exchange-traded funds on raw materials and companies with lower capitalization and liquidity.

"It is possible that, in the short term, the prices of these underlying securities will be significantly influenced by the prices of some ETFs that have a significant weight in the market for these assets," they conclude.

Another positive view of investing in ETFs is offered by Kevin Koh Maier, Investment Director at Finizens, —a firm dedicated to passive management with ETFs from other managers— who explains that “the diversification of an index-linked fund makes any event especially negative in a company not even notice the investor in its total profitability ".

In addition, he considers that ETFs have shown a good example of their liquidity in difficult times such as March and April of last year.

"The index is usually more liquid than a security and, so far, there have been no problems in this regard."

This expert also warns of the different biases that, for example, the different indices of the world's Stock Exchanges have.

For example, in Europe the indices have a greater weight of traditional economy with banks and insurers compared to the Americans more focused on technology.

Fiscal ballast

Quoted or indexed funds arrived in Spain in 2006, although before that there was an ill-fated experience called Fastibex, a listed portfolio company that was dedicated to investing in Ibex 35 securities and which ended up being liquidated in 2003. The idea of ​​indexed investment appeared on the Toronto Stock Exchange (Canada) at the end of the nineties, and arrived in Europe in 2000 at the initiative of the Frankfurt and London Stock Exchanges.

In Spain there are no very reliable statistics of ETFs and index funds in the hands of savers, without the Association of Collective Investment Institutions (Inverco) making a clear differentiation of this type of investment.

One of the most relevant aspects that differentiates ETFs from other investment funds is their tax treatment.

ETFs trade like stocks, away from the fund regime.

But its main drawback compared to its brothers is that it is always paid when the ETF is sold and it is not possible to reinvest that money in another fund to avoid taxation as it is the case with other investment funds.