Critics who assail the growing influence of index giants like BlackRock Inc. may be overlooking their power to prevent a stock-market disaster.
In a paper published this month, academics from America and China show that institutions with notable holdings in multiple firms across industries are less likely to panic sell.
Using almost four decades of U.S. data, they find that these investors are stabilizing forces because they can figure out whether equity gyrations are down to firm- or industry-specific woes.
It’s a timely addition to the ever-more contentious debate about whether asset managers are acquiring too much influence in world finance. Just last week, BlackRock’s second-quarter results showed the firm managing a record $9.5 trillion, with its exchange-traded funds controlling more than $3 trillion for the first time.
Big Three
These rising ownership stakes have prompted fears over increased market volatility because for the most part the funds passively buy and sell, often in unison. But the paper, titled “The Information Advantage of Institutional Common Owners: Evidence from Stock Price Crash Risk,” comes to the opposite conclusion.
“Our findings support the stabilizing role of institutional common owners in the market due to their information advantage,” the academics wrote. That allows money managers “to better differentiate between the firm-specific and industry-wide nature of bad news, thus avoid selling on false signals,” the authors said.
Qingyuan Li from Wuhan University, Xiaoran Ni from Xiamen University, P. Eric Yeung from Cornell University and Sirui Yin from Miami University studied ownership data and market movements between 1980 and 2017. In that time, the percentage of publicly traded U.S. firms with a common institutional owner -- defined as holding 5% or more of multiple companies in one industry -- increased to over 80% from 10%.
The academics found the crash risk -- essentially, whether a share price will drop excessively in the year ahead -- to be significantly lower for companies with at least one common owner versus those without. The theory is that the co-owners won’t panic sell because they can better discern between a company-level crisis and an industry implosion.
Crucially, they also provide evidence that the phenomenon is driven by “non-dedicated” common owners. In other words, institutions with large holdings in a broad set of companies.
“Some professional investors believe that passive ‘indexing’ strategies discourage price discovery, which may increase crash risk due to the mispricing,” the authors wrote. This “is inconsistent with the effect of common ownership.”