A study conducted by the investment firm Leuthold Group found that stock sectors with the heaviest level of passive ownership fell more than the broad market during this year’s selloff. This according to a recent article in The Wall Street Journal.
“The question is whether this says something about how index funds perform in a crisis, compared with actively managed funds, or is just a reflection of how certain sectors were more vulnerable to the selling pressure,” the article says.
As part of the study, Leuthold portfolio manager Jun Zhu analyzed data from February 19th through March 23rd and found a correlation between sectors with above-average levels of passive ownership and underperformance. Examples included financial stocks, real-estate holdings, energy sector stocks and consumer-discretionary stocks. She wrote, “It’s logical to say that sectors with highest passive ownership will fall more during a selloff. My thinking is that it’s because ETFs will sell immediately when investors redeem assets; they don’t need to peek under the hood to decide which stocks to sell.”
The article notes, “this isn’t the first time that the trend toward passive ownership has come under scrutiny, resulting in some intriguing and sometimes controversial findings and arguments.”
But WestEnd Advisors managing partner Mike Goldman cautions against confusing causation and correlation: “What’s more important in determining what sectors do well is the extent to which they are highly tied to the business and economic cycle” rather than whether they have a high degree of passive ownership. He explains that the most cyclical businesses have been the hardest hit while defensive stocks (like utilities) fared better during the selloff.
The article notes, “That doesn’t mean Ms. Zhu’s approach is invalid,” noting that her emphasis is on relative performance of individual stocks within a sector rather than between sectors.
Zhu and Goldman agree, however, that when sector returns diverge as much as they did during the recent selloff, it’s worth taking a hard look at sector-based investing. Ultimately, the article concludes, Zhu’s study “marks another step along the path to understanding the impact of the surge in interest in passive funds on the market.”