It’s getting harder and harder to lay the blame for last month’s market rout squarely on passive investors.
Index trackers were in the firing line after some technology-focused exchange-traded funds were forced to ditch billions of dollars of Facebook Inc. and Alphabet Inc. in late September. Some speculated that the sales fed a broader stock-market correction that began a few days later.
But as regulatory documents disclosing trades by active managers trickle out, it’s clear passive investors made up a relatively small contingent of sellers. Hedge funds were net sellers of both companies last quarter, data compiled by Bloomberg show, with the likes of Appaloosa Management and Viking Global Investors cutting stakes. While the filings don’t pinpoint the timing of these trades, they indicate a broader souring of sentiment around the two firms.
“When you start thinking about more active money out there today, it’s still effectively at least double” ETFs, said Joe Smith, deputy chief investment officer at Omaha, Nebraska-based CLS Investments, which manages $9 billion. “There’s a lot of names that have been bid up. Now that we’re going through the earnings seasons and also some of these changes that have occurred, people are finally starting to look under the hood.”
Facebook has a $414 billion market capitalization; Alphabet is worth $743 billion. They’re both giants next to ETFs with about $40 billion of assets that have been implicated in the worst month since 2011 for U.S. stocks.
What Happened
It’s all part of the greater scrutiny that passive investing is attracting as it conquers a larger and larger region of the market. That growth has spurred legitimate concerns about how indexing affects volatility, liquidity and valuation -- as well as the growing influence of the companies that create and maintain these benchmarks.
In this instance, S&P Global Inc. and MSCI Inc. -- two of the largest index providers -- decreed last year that Facebook and Alphabet should no longer be considered technology companies. The duo were spun out of some tech-focused benchmarks and into a new communications services sector, alongside Netflix Inc., which moved from the consumer discretionary category, and a bunch of old-school telecom stocks. Two large tech ETFs run by State Street Corp. and Vanguard Group had to sell their stakes as a result.
“The stocks that were sold were also very volatile, which means if there wasn’t a concurrent buy as part of the rebalance, then they would probably move a lot more than average,” said Oliver Brennan, a London-based macro strategist at TS Lombard, who wrote a note arguing that sector rebalancing helped stocks roll over. “I’m not trying to suggest the trigger and the sole cause for the selloff was the rebalance, but it happened at the exact worst time.”
‘Everyone Knew’