Robert Shiller on what worries him about passive investing from CNBC.
Economic guru and Nobel winner Robert Shiller is questioning the value and role passive investing is playing in the bull market.
He is seeing worrisome issues surrounding the growing popularity of index funds and ETFs among retail investors, Shiller, who also helped develop the widely-followed S&P/Case-Shiller Home Price Indices, told CNBC.
"The strength of this country was built on people who watched individual companies. They had opinions about them. All this talk of indexes, it's a little bit diluting of our intellect. It becomes more of a game," the Yale economics professor said.
"It's a chaotic system," said Shiller, who was awarded the Nobel Prize in Economic Sciences with Eugene Fama and Lars Peter Hansen in 2013.
He compares passive investing to seeing a green light at an intersection and crossing the street without looking both ways.
"The problem is that if you are talking about passive indexing, that is something that is really free-riding on other people's work," Shiller said. "So people say, 'I'm not going to try to beat the market. The market is all-knowing.' But how in the world can the market be all-knowing, if nobody is trying — well, not as many people — are trying to beat it?"
Shiller isn't alone in his hesitation of passive investing.
"The growth of exchange-traded funds and passive investing since the financial crisis has been so huge they could unwittingly be central to the next major market downturn," Reuters columnist Jamie McGeever recently warned.
The structure and size of ETFs, together with the trend-following nature of passive funds, mean the breadth of selling from this investor base when the market does turn south could quickly accelerate, McGeever wrote.
Richard Turnill at Blackrock, the world’s largest asset management firm which runs some of the world’s biggest ETFs, said one of the main reasons markets survived recent rocky rides was precisely the liquidity provided by ETFs.
ETFs were originally designed as investment vehicles for retail investors and households. But large institutional funds and asset managers are taking over, and the scale of money involved means these products can move markets much more easily.
Blackrock pulled $140 billion into its ETFs in the first half of this year, more than the total for all of last year. Over $80 billion has poured into Vanguard ETFs, well on course to beat last year’s record $97 billion.
Although they have survived a few market scares in recent years and even thrived subsequently, ETFs are essentially untested. They came to prominence after the 2008 crisis and there hasn’t been a market shakeout anywhere near that magnitude since.
To be sure, investors pulled $19.3 billion from BlackRock’s U.S.-based actively managed mutual funds in 2016, Morningstar estimates showed, a record high as the investment industry struggles to restrain an exodus to lower-cost investments, Reuters reported.
The funds posted nearly $8.5 billion in outflows during last year's fourth quarter, the research service said.
An industry bellwether, New York-based BlackRock also owns one of the most prized businesses in asset management, its iShares exchange-traded funds franchise.
That business has profited from investor’s shift from active to passive funds. Many ETFs are relatively low cost and aim merely to track the market, not to beat it.
U.S.-based actively managed stock funds suffered $288 billion in withdrawals in 2016 through November, the largest on record, according to Thomson Reuters Lipper service. The figure tops outflows of $139 billion in 2015 and $218 billion in 2008.
On the passive side, stock index mutual funds and equity exchange-traded funds each attracted about the same amount of new cash, more than $112 billion apiece in 2016, Lipper said.
(Newsmax wire services contributed to this report).