Passive Funds Face an Active Nightmare
There are hundreds of stock market constituents working overtime to limit lockdown damage; it’s inevitable that some will lose the pack. It’s also very competitive to list on America’s most esteemed exchanges, so stock market status is at risk for some.
There are rules-based requirements a company must meet to be in contention for listing. The S&P 500 demands liquidity, profitability, and a minimum market capitalization of 8.2-billion-dollars. It’s up to index compilers to reshuffle members periodically, and index fund managers to buy and sell the arriving and departing companies, respectively.
Index funds hold every stock on a stock exchange. It’s money for old rope to manage one; they require no active management, or so we thought. It seems more stocks will need reshuffling than has been the annual average for over thirty years, and passive funds are so popular now that huge block trades will be required to make the changes.
The funds cost a pittance because they normally require no superstar stock picker, but now the transaction costs for moving this much money are insane. It won’t be feasible to sell all the demotees and buy all the promotees, especially considering the coronavirus impact may be temporary. There could be delisted companies that need bringing back!
This has forced index managers into judgment calls; “will this company be permanently affected by coronavirus relative to other companies? Should we ditch it now, or wait?”
It’s contentious because passive investors specifically don’t want their money managed according these kinds of decisions, speculative predictions of the future. These funds aren’t doing their job if they don’t track their index properly, though, and could see withdrawals. They also represent a key macroeconomic signal. Something’s got to give!
