The passive investment bubble

• DOI: http://doi.org/10.1002/jcaf.22437
• Date: 01 January 2020
• Published date: 01 January 2020
• Author: Damir Tokic

EDITORIAL

The passive investment bubble

Damir Tokic

International University of Monaco and

INSEEC U, Monaco, Monaco

Correspondence

Damir Tokic, International University of

Monaco, Monaco, Monaco.

Email: tokic_d@yahoo.com

Abstract

Since the 2008 financial crisis, investors have significantly increased their

allocation to passive investment vehicles, such as the exchange traded funds.

At the same time, the active investment funds experienced significant outflows

as their performance underperformed the major indices. As the result of these

capital flows, the market participation balance potentially changed, which

increased the possibility of a market bubble—which some already define as

the passive investment bubble.

KEYWORDS

active investing, alternative monetary policy, passive investing bubble

1|INTRODUCTION

During the period since the 2008 financial crisis, investors

have been pouring their funds into the passive investment

vehicles such as the exchange traded funds (ETFs). For

example, Divine (2019) points to the fact that “in 2009

active funds had nearly three times more assets under

management than passive funds,”while in 2019 “passive

funds overtook active funds by market share.”. In fact, the

Fed's flow of funds data confirm the extraordinary invest-

ment allocation trend into the ETFs since 2008, when the

market value of ETFs holdings in equities by the ETFs

was just over $400 million, and grew to nearly $3.2 trillion

by 2019 (Exhibit 1). Thus, some experts question whether

there is a bubble brewing due to inflows into the ETFs.

For example, Michael Burry, a hedge fund manager who

correctly predicted the housing bubble in 2008 and the

resulting financial crisis, believes that there is a passive

investment bubble (Kim & Cho, 2019).

This article discusses the apparent bubble in passive

investing, along with likely causes and potential conse-

quences. But first, it is important to understand a defini-

tion of a bubble, and the difference between the passive

and active investing strategies.

2|WHAT IS A BUBBLE?

A bubble is simply a valuation phenomenon when an

assets’price significantly and persistently exceeds the

asset's true or fundamental value. In one of the early bub-

ble definitions, Kaldor (1939) states that a bubble

develops whenever somebody buys an asset with the sole

purpose of reselling that asset at a higher price, without

any regards for the assets’fundamental value. Delong,

Shleifer, Summers, and Waldmann (1990) develop a spe-

cific model whereby trend followers (or positive feedback

traders) buy an asset solely based on its historical price

trend, disregarding the asset's fundamental value. Thus, a

trend of rising prices attracts more trend followers who

push the prices even higher. Consequently, the asset's

price reaches the bubble phase, which lasts for as long as

the trend-followers keep buying, and eventually collapses

as the trend-followers all rush for the exits at the same

time, as the trend changes.

3|ACTIVE INVESTING

STRATEGIES AND MARKET

EFFICIENCY

Nevertheless, the efficient market hypothesis (EMH)

rules out the financial asset price bubbles, and states that

Correction added on December 19, 2019, after first online publication:

Article category updated from “Editorial Review”to “Editorial.”

Received: 28 November 2019 Accepted: 28 November 2019

DOI: 10.1002/jcaf.22437

J Corp Acct Fin. 2020;31:7–11. wileyonlinelibrary.com/journal/jcaf © 2019 Wiley Periodicals, Inc. 7