The CSR Newsletters are a freely-available resource generated as a dynamic complement to the textbook, Strategic Corporate Social Responsibility: Sustainable Value Creation.

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Monday, October 24, 2016

Strategic CSR - Passive investing

The article in the url below focuses on the effects of the growing trend of passive investing (e.g., exchange-traded funds) on overall market performance. This is interesting because passive investing is being increasingly sold to armchair investors as a 'safe' way to invest in the market:
 
"The argument goes like this: the stock market will outperform other investments over the long term, yet no individual is in a position to outsmart the market as a whole. So the best way to reap the rewards of investing in stocks with minimal risk is to put your money in a fund that tracks the performance of some broad, indexed measure of the market, such as the S&P 500."
 
In reality, however, the greater the proportion of the total market that is invested in funds designed to track the overall market, the greater the extent to which these funds become a self-fulfilling prophecy. In other words, they become the market, rather than reflecting the market:
 
"It stands to reason that beyond some threshold, a market that has more passive than active investors will behave differently than markets have in the past. One way to think about this is to imagine that investment decisions are increasingly on autopilot: more and more money will pour into a set of firms largely independent of the considerations that have traditionally guided investors, such as supply, demand, management performance, growth potential, or broader economic factors."
 
The result is an even greater distortion of what the stock market represents (and the overall value that it adds):
 
"Typically, stocks are indexed by market capitalization—the value of a firm's share price times the number of shares—from highest to lowest. A market with more passive investors than active ones will continue to push money into the largest firms, whether these companies are actually performing strongly or not."
 
Inertia is a strong force, affecting everything from business school rankings to our weekly shopping list. It is not hard to see the potentially distorting effects it can have on the stock market:
 
"Timothy O'Neill, the global co-head of Goldman Sachs' investment-management division, [said] that essentially every new indexed dollar goes to the same places as previous dollars did. This 'guarantees that the most valuable company stays the most valuable, and gets more valuable and keeps going up. There's no valuation or other parameters around that decision,' he said. … Such effects already exist today, of course, but the market is able to rely on active investors to counteract them. The fewer active investors there are, however, the harder counteraction will be."
 
Other potentially damaging effects of the growing influence of passive investors/funds are discussed in the article.
 
Take care
David
 
 
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Is Passive Investing Actively Hurting the Economy?
By James Ledbetter
March 9, 201
The New Yorker
http://www.newyorker.com/business/currency/is-passive-investment-actively-hurting-the-economy