Developments in the asset management industry.

• Author: Ben-David, Itzhak

Over the last two decades, the asset management industry has witnessed dramatic developments in both industrial organization and product offerings. Two or three decades ago, the industry was dominated by small asset managers primarily offering active portfolio management services. Today, the industry is significantly more concentrated and the leading products are index-based passive investment vehicles. My recent research examines some of the consequences of these developments.

The asset management industry is significantly more concentrated today than a few decades ago. Figure 1 shows the dramatic increase in industry concentration: in the United States, the top 10 managers owned about 5 percent of the U.S. stock market in 1980, whereas in 2016 they owned about 23 percent. Francesco Franzoni, Rabih Moussawi, John Sedunov, and I find that this development has increased the volatility of the underlying securities in the U.S. stock market. (1) Our hypothesis is that this increase in concentration has led to disproportionately larger trades by asset managers, which in turn has led to greater volatility in the underlying securities.

There are many anecdotal examples of this phenomenon. For example, the September 2014 departure of Bill Gross, co-founder of PIMCO, the largest bond fund, led to large withdrawals. In turn, PIMCO's Total Return Fund had to liquidate a large fraction of its holdings, leading to an impact on bond and futures prices. Other examples include trades by the London Whale in JP Morgan and the computer glitch at the large broker Knight Capital that led to massive selloff of equities in 2012. But massive trades by large institutions are not necessarily a result of cataclysmic events. They may be the result of portfolio rebalancing, or correlated trades across units within the organization--for example, if units use the same information provided by a single research department, or flows from investors are driven by a marketing effort of the organization. Nevertheless, large institutions could cause market disruptions since their trades are large relative to typical market volume.

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We identify the causal effect of large institutional investors on volatility using two main techniques: First, we exploit the fact that prior research documented that top institutional ownership is higher for local stocks, thus allowing a plausibly exogenous shock to top institutional ownership. Second, we examine the change in institutional ownership following the 2009 merger of Barclays Global Investors, the largest asset manager, and BlackRock, the 14th largest. Following the merger, the size of the largest asset manager increased by 40 percent. Using these identification strategies, we find that the large trades of the top institutional investors increase volatility. We suggest that these trades introduce noise to prices, and that the effects are particularly strong during times of market stress.

Another significant development in the asset management industry is the introduction of exchange-traded funds (ETFs). These...