Categories Online News Press Wealth

Apollo, Citadel Flag Hidden Costs of Passive Investing

(Bloomberg) — Apollo Global Management and Citadel, giants in the world of active investing, are both pointing out risks that exist as passive funds gain in prominence.

At Apollo, the view is that the hidden costs of the passive-investing juggernaut include higher volatility and lower liquidity. Ken Griffin’s Citadel, meanwhile, says regulators undervalue active managers’ role and are crimping their growth. US exchange-traded funds — a bastion of passive investing — have record net inflows of $913 billion this year, and combined assets exceeding $10 trillion, thanks to the buoyant US stock market.

report by Apollo managers Felix von Moltke and Torsten Slok focused on “higher asset-price volatility, reduced liquidity, and possible contribution to heightened market concentration.”

For large company shares in particular, growth in passive investment — which is always on the long side — “makes it more unattractive and more risky to be short, which again means more upward momentum in the price of large stocks,” von Moltke and Slok wrote. “When active investors turn passive, large cap stocks will benefit disproportionately.”

Passive investors account for more than half of the assets in mutual and exchanged-traded funds globally, they said.

Citadel’s global head of government and regulatory policy, Stephen Berger, meanwhile spoke on a panel at a conference organized by the Federal Reserve Bank of Cleveland and the Office of Financial Research on Thursday. He said passive investing created financial stability risks, even as it has provided “very positive” low-cost market access for many investors.

The success of passive management, he said, “is predicated upon having active managers who are continuing to do the fundamental research to identify what’s undervalued, what’s overvalued, and then expressing those thesis in the market in a way that maintains accurate pricing, maintains efficient pricing, and by extension ensures that there’s the optimal allocation of capital to the economy and to relative assets.”

In some cases, Berger said, oversight is “impairing the ability of a shrinking universe of active managers to continue to do the job that they need to do,” Berger said. To the extent this happens, “I think we end up with much more system-wide challenges with respect to valuations and capital allocation that likewise could present a material financial stability risk.”