A discrepancy in Schroders’ share price has been highlighted as the latest evidence of how the rise of passive investing is playing out in unusual ways - and potentially distorting equity valuations.
In a sign of passives' growing dominance, Bank of America Merrill Lynch (BAML) noted yesterday the percentage of S&P 500 shares held by Vanguard alone has doubled to 6.8 per cent since 2009. The trend is also playing out in markets closer to home, specifically in the shares of an active manager attempting to stand firm in the face of passives’ popularity.
Like its FTSE 100 peers, Schroders has seen passive funds gain a stronger foothold on its shareholder register as UK equity tracker products attract greater investor interest.
But the asset manager is unlike most UK firms in that it offers a non-voting share class that is distinct from its conventional shares, which have voting rights attached.
According to Jamie Ward, a UK equity manager at Crux Asset Management, the discount at which non-voting shares typically trade has blown out in recent months because passive buying is concentrated on the regular share class.
“There is a lot going on with exchange-traded fund (ETF) flows. Historically the non-voting shares trade at a slight discount, and really the vote is worth nothing anyway because the Schroder family has a controlling stake,” Mr Ward said.
“The discount has been moving up, and peaked [at the end of June] at around 30 per cent.”
Mr Ward’s Crux UK fund holds this share class among its top investments. Schroders’ voting shares have risen 30.4 per cent over the past 12 months, while the ‘C’ non-voting class is up 22.4 per cent.
The lesson from these shifts, according to BAML research on the ‘ETF-ization’ of the S&P 500, is to focus on buying under-owned stocks, not least those that do not have a significant passive presence on their share register.
“Stocks most held by passive investors have seen higher volatility than the market, measured by both price declines and standard deviations. And the average price volatility of stocks with low "true float" (i.e. those with a high proportion of float held by passive) tripled in the last 12 months,” BAML analysts said.
Identifying areas to avoid, the investment bank predicted that the next ETF surge may be into value products and sustainable investment strategies. That would mirror the jump in low-beta stock valuations that has accompanied the rise in low volatility ETF investing since 2009.
BAML’s figures state that the proportion of the S&P 500 held by passive rather than active funds is now 37 per cent, up from 19 per cent in 2009. Others contest this figure, but Fidelity’s equity chief investment officer Dominic Rossi predicted at the end of June that passives would account for 50 per cent of the index within the next year.
The bank said the shift to passive can go much further before markets start to become “dysfunctional”, given the example of Japan. Aided by the country’s central bank buying ETFs as part of its quantitative easing programme, almost 70 per cent of Japan equity fund assets are now passive.
The lesson is stark for active managers who do not seek out under-owned shares, BAML concluded.
“The victim in Japan has been active equity managers. Over the past three years of extreme ETF inflows, Japan-focused active funds suffered benchmark outperformance rates 12 per cent lower than prior decade's average.”
