The Shift from Active to Passive Investing: Potential Risks to Financial Stability?

34 Pages Posted: 2 Sep 2020 Last revised: 3 Sep 2020

See all articles by Kenechukwu Anadu

Kenechukwu Anadu

Federal Reserve Banks - Federal Reserve Bank of Boston

Mathias S. Kruttli

Board of Governors of the Federal Reserve System; University of Oxford - Oxford-Man Institute of Quantitative Finance

Patrick E. McCabe

Board of Governors of the Federal Reserve System

Emilio Osambela

Board of Governors of the Federal Reserve System

Multiple version iconThere are 3 versions of this paper

Date Written: August, 2018

Abstract

The past couple of decades have seen a significant shift in assets from active to passive investment strategies. We examine the potential effects of this shift for financial stability through four different channels: (1) effects on investment funds’ liquidity transformation and redemption risks; (2) passive strategies that amplify market volatility; (3) increases in asset-management industry concentration; and (4) the effects on valuations, volatility, and comovement of assets that are included in indexes. Overall, the shift from active to passive investment strategies appears to be increasing some types of risk while diminishing others: The shift has probably reduced liquidity transformation risks, although some passive strategies amplify market volatility, and passive-fund growth is increasing asset-management industry concentration. We find mixed evidence that passive investing is contributing to the comovement of asset returns and liquidity.

JEL Classification: G10, G11, G20, G23, G32, L1

Suggested Citation

Anadu, Kenechukwu and Kruttli, Mathias S. and McCabe, Patrick E. and Osambela, Emilio, The Shift from Active to Passive Investing: Potential Risks to Financial Stability? (August, 2018). FEDS Working Paper No. 2018-060R1, Available at SSRN: https://ssrn.com/abstract=3242660 or http://dx.doi.org/10.17016/FEDS.2018.060r1

Kenechukwu Anadu (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Boston ( email )

600 Atlantic Avenue
Boston, MA 02210
United States

Mathias S. Kruttli

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

HOME PAGE: http://www.federalreserve.gov/econresdata/mathias-s-kruttli.htm

University of Oxford - Oxford-Man Institute of Quantitative Finance ( email )

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Oxford, Oxfordshire OX2 6ED
United Kingdom

HOME PAGE: http://sites.google.com/site/mathiaskruttli/home

Patrick E. McCabe

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Emilio Osambela

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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