Did index-fund ownership harm certain stock sectors?

Study finds stocks with highest passive ownership levels declined more rapidly than broader market

Did index-fund ownership harm certain stock sectors?

The results of a new study correlating certain stocks’ underperformance with passive ownership may provide more ammunition for critics of index-fund investing. But for those holding opposing views, it begs a few questions.

Conducted by Minneapolis investment firm Leuthold Group, the study examined data from the first weeks of the drastic market slide driven by COVID-19 and the ensuing nationwide lockdowns, reported the Wall Street Journal. The analysis found that stocks that were most heavily owned by passive index funds and sector ETFs declined more rapidly than the broad stock market or peers that tended more to be owned by active funds.

Over the market top-to-bottom period of February 19 through March 23, stocks with the highest passive-ownership levels declined by almost three percentage points more than names more likely to be owned by stock-pickers (40.4% vs. 37.5%), who may now have a chance to prove their worth.

“Stocks with high passive ownership in the sectors with the greatest selling pressure underperformed,” said Jun Zhu, a portfolio manager at Leuthold who performed the analysis, in a note published within the firm’s “Green Book” of research analysis in April.

Among them were those in the financial sector, real-estate holdings, energy, and consumer-discretionary stocks. Healthcare companies showed somewhat trend-bucking performance, losing “only” 30.3% compared to energy companies’ 60.7% loss and 45.2% for financial services.

“My thinking is that it’s because ETFs will sell immediately when investors redeem assets [during a selloff],” Zhu told the Journal, commenting on the possible reason behind the outsized fall among sectors with high passive ownership. “They don’t need to peek under the hood to decide which stocks to sell.”

Some may argue that levels of losses incurred by stocks are more tightly tied to how tethered they are to the business and economic cycle. Zhu countered that her analysis emphasized relative performance of individual stocks within a sector. “[W]e see performance divergence within the energy sector among companies that have high passive ownership versus low passive ownership,” she noted.

But Shelly Antoniewicz, senior director of industry and financial analysis at the Investment Company Institute (ICI), noted that other factors — including size, profitability, and value — can exert a differential impact on stock performance even within sectors.

Zhu conceded that the cyclicality of other factors can be one determinant of performance. But she also asked: “How do we know the rise and fall of passive ownership is not due to investors chasing whatever factors are working right now?”


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