Passive Money Flows in Financial Markets: A New Force to Reckon With

When it comes to financial markets, the influence of fundamental forces is well known. But, in recent times, there has been a growing trend of passive money flows that are changing the landscape of the stock market. These flows, driven by institutions such as Blackrock ETF, Vanguard ETF, and big pension funds, are becoming increasingly important players in equity markets, and their contribution is only expected to grow. In this article, we will discuss the significance of passive money flows and how they are shaping the future of financial markets.

What Are Passive Money Flows?

Passive money flows refer to the investment strategy where funds track the performance of a particular market index, such as the S&P 500, rather than actively picking stocks. These funds are designed to mimic the performance of the index, and the investment decisions are based on predetermined rules. For instance, if a stock is added to the index, the fund automatically buys it, and if it is removed, the fund sells it. This means that passive funds are always fully invested in the market, and the fund managers do not have any discretion in picking stocks.

The Growing Importance of Passive Money Flows

Passive money flows have been gaining traction in financial markets over the past decade. The data shows that passive flows now make up around 20% of the total S&P 500, and this trend is expected to continue. One reason for this is the lower cost associated with passive funds, which have become increasingly popular among investors. Additionally, passive funds are perceived to be less risky than actively managed funds, as they are diversified across a range of stocks, reducing the impact of individual stock price movements.

Percentage of Stock Market Comprised of ETF’s

However, the impact of passive money flows goes beyond cost savings and diversification benefits. These funds are becoming critical players in the equity markets, and their investment decisions are having a significant impact on the market. For example, when passive funds buy or sell a stock, it can cause a ripple effect on the market, leading to a rise or fall in the stock price. This means that passive money flows are becoming a new force to reckon with in the financial markets. This trend in Equity Funds moving to passive management has been increasing steadily for some time, with over 50% of ETF’s using passive management at the start of 2021

Passively Run ETF’s – Bloomberg

The Mechanisms of Passive Money Flows

Passive funds base their investment decisions on simple mechanisms, such as volatility. They use volatility metrics such as the VIX and spreads in bond yields to determine when to buy or sell. When volatility is low, they will buy, and when it is high, they will sell. This means that passive funds are not concerned with the fundamentals of individual companies but rather focus on the overall market sentiment.

The Future of Passive Money Flows

The future of passive money flows is promising, and their influence is expected to grow even further. As more investors embrace passive investing, the total amount of passive money flows in the market will increase, making them even more significant players in the financial markets. Additionally, the simplicity of the investment strategy means that it is easy for investors to understand and follow, making it an attractive option for those who are new to investing.

Furthermore, the recent tightening of bond yield spreads, the low VIX, and the relative certainty of central bank policies suggest that passive flows are likely to continue buying in the market for the foreseeable future. This is expected to be stimulative to markets, creating more opportunities for investors to benefit from the growing trend of passive investing.

2-year & 10-year US government Bond Yields demonstrate the current yield curve inversion and the 2y/10y yield spread which is wider when perceived volatility in the market/economy is high and shrinks when this perceived volatility is low.

Conclusion

Passive money flows are becoming an increasingly important force in the financial markets, with their investment decisions having a significant impact on the market. As the trend of passive investing continues to grow, it is essential for investors to understand the mechanisms behind it and its implications for the market. While the impact of passive money flows is not always straightforward, it is a trend that is here

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