Morningstar Advisor - February/March 2012 - (Page 61)

we study how this rise in systematic risks connects with the rise in popularity of passively managed index funds and the associated increased trading commonality. Through a battery of tests, we examine the impact of trading commonality related to passive investing and how this affects systematic market risk. Wurgler (2010)1 reviewed the consequences of index investing and suggests that index investing is distorting both stock prices and risk/return trade-offs. This, in turn, may distort a host of things, including corporate investment and financing decisions, investor portfolio allocation decisions, and assessments of fund manager skill. These effects could intensify if index-linked investing continues to gain popularity. Growth in Index Trading Exhibit 1 Equal-Weighted Average Betas for U.S. Stocks by Size and Style: Equal-weighted average betas for all categories have risen and converged since 1997. Beta (%) Large (1 yr avg) Small (1 yr avg) Growth (1 yr avg) Value (1 yr avg) 1.4 1.2 1.0 0.8 0.6 0.4 During the past three decades, there has been substantial growth in institutional investing. The average portion of a firm’s equity shares held by institutions has grown from 24% in 1980 to 44% in 2000 and to 70% in 2010. The influence of institutional investing has been steadily growing and has become a dominant force in today’s stock market activity. As the role of institutional investors has increased, the amount of assets invested in index mutual funds and ETFs has also risen rapidly. Exhibit 2 compares total U.S. equity assets under management for active mutual funds versus passively managed funds from February 1993 to September 2010. We measure passively managed investments as assets invested in index mutual funds plus ETFs.2 As of October 2010, total assets in equity mutual funds and ETFs reached $3.5 trillion. Of that, $2.3 trillion was actively managed, with the remaining $1.2 trillion being passively 09/ 81 09/ 83 09/ 85 09/ 87 09/ 89 09/ 91 09/ 93 09/ 95 09/ 97 09/ 99 09/ 01 09/ 03 09/ 05 09/ 07 09/ 09 Exhibit 2 Growth in Equity Fund Assets by Type of Fund: Passive funds have experienced about double the growth rate of active funds since 1997. ($) Total Passive Funds Total Active Funds 5 tril 4 3 2 1 02/ 93 02/ 94 02/ 95 02/ 96 02/ 97 02/ 98 02/ 99 02/ 00 02/ 01 02/ 02 02/ 03 02/ 04 02/ 05 02/ 06 02/ 07 02/ 08 02/ 09 02/ 10 1 Wurgler, Jeffrey. 2010. “On the Economic Consequences of Index-Linked Investing.” Forthcoming in Challenges to Business in the Twenty-First Century: The Way Forward, W.T. Allen, R. Khurana, J. Lorsch, G. Rosenfeld, Eds. American Academy of Arts and Sciences. 2 Most ETFs—although not all—have passive mandates and track an index, such as the S&P 500 or the Russell 3000. MorningstarAdvisor.com 61 http://www.MorningstarAdvisor.com

Table of Contents for the Digital Edition of Morningstar Advisor - February/March 2012

Morningstar Advisor - February/March 2012
Contents
Contributors
Letter From the Editor
Make a Difference Stories, Not Debates
How Concerned Are You About Europe?
Analytical and Independent
What to Ask When a Fund Manager Leaves
Past, Present, Future
Have Financials Gotten Cheap Enough?
Four Picks for the Present
Investment Briefs
Tactical Funds Miss Their Chance
Specialty Retail: Ad Hoc Opportunity
How Europe Is Making Its Crisis Worse
Impact on U.S. Economy Will Be Minimal
European Banks: Bargains or Value Traps?
Don’t Count the Euro Out Yet
Europe on the Brink
GoodHaven Realizes Its Vision
How Index Trading Increases Market Vulnerability
Nonlisted REITS: Handle With Care
Safety Picks for the Many Moods of Mr. Market
On the Prowl for Large- Blend Index-Beaters
Our Favorite Mutual Funds
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
The Math That Matters

Morningstar Advisor - February/March 2012