The Hidden Cost Behind Passive Investing
Financial markets have surpassed a historic milestone. According to Morningstar, assets managed by passive investment strategies in the U.S. ($13.29T) have exceeded the assets under active management ($13.23T). The decade long migration from active to passive investing shows no signs of slowing as traditional active managers continue to underperform markets.
However, this means that more investors are exposed to an inherent problem with passive investing.
Super Micro Computer, Inc. gets added to S&P 500
S&P announced on Friday, March 1st 2024 that Super Micro Computer, Inc. (SMCI) would be added to the S&P 500 index. The following Monday, SMCI stock price jumped +19.13% at the opening bell.
Trading volumes were elevated on two dates in March.
4th of March, the trading day after the announcement saw trading volumes spike to 20 million. The other date was 15th of March, the last trading day before SMCI is added into the S&P 500 index.
Between March 1st and March 15th, SMCI stock price increased by +18.04% while the S&P 500 Index declined by -0.32%, giving SMCI a relative outperformance of 18.36%.
Because passive tracking funds have to include SMCI into their holdings by the time it is officially added into the S&P 500 index, we often see large trading volumes on the very last day and very last thirty minutes of the trading day before a particular stock is added into the index. The implication is that, investors have to buy SMCI at a premium because they are demanding immediacy from the market and essentially becoming a price taker, buying the stock at any price.
Most people would not do this for purchases in the course of their daily lives.
If you went out to buy a house or a car, would you pay the asking price of the seller immediately?
It is unlikely.
You would try to get a better deal out of it.
If we do this for our purchases in the course of our daily lives, why do investors not do it for their investments?
The Indexing Effect
This well studied phenomena is known as the “indexing effect”. Companies anticipated to be added into the index outperform the index between the announcement and effective date followed by underperformance post addition and vice-versa for deletions.
Since being added to the index, SMCI has declined -28.68% (ending 19th April 2024).
Our approach of having flexibility in trading securities allows us to sit out these periods of high buying pressure and not pay the cost of demanding immediacy. Incorporating information that affect short-term expected returns such as momentum and securities lending fees allows us to buy these stocks at more attractive times because we are not blindly anchored to the benchmark.
Click here if you would like to find out more how our flexible approach goes beyond passive investing to help you deliver better investment outcomes.
Most of us would trust an accomplished physician to manage our health. After all, physicians have specialised training, real-world experience, and access to tools outside the reach of the general public. Most importantly, they took an oath to prioritise the patient’s health over their own interests.
In the same fashion, GYC espouses the same expertise in markets as good physicians do with health care. Additionally, we adapt insights from financial science to develop a financial plan that is built upon a rigorously tested investment philosophy.
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