December 2020 – Passive Market Share Update

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We have updated our paper on passive investing and its effects on US stocks. The paper is available for free download here.


Passive Ownership of Major Companies

The largest three passive firms continued gobbling up shares of US equities in Q3 20. Below are the percentages of each firm owned by the “Big 3.” These amounts only include the Big 3, but be wary, aside from the behemoths, there are a significant number of additional funds and firms indexing.

Company Ticker % Passive
Exxon Mobil XOM 20.3
Microsoft MSFT 19.2
Bank of America BAC 16.7
3M MMM 19.7
McDonald’s MCD 20.6

Once a share of stock enters the vaults of the Big 3 – we believe it should be excluded from the “float” or shares available to trade. Passive firms hold their investments indefinitely, as long as there are inflows to the firm. The Big 3 have enjoyed inflows for more than a decade and even through the Q1 2020 market decline. Effectively, this means the floats of the above companies are 20%+ smaller than first glance.


It Doesn’t Work in Reverse

What happens when the big passive players have net outflows? It has never occurred before, and we believe stock market collapse ensues. Not only does the effective float of every company increase by 20-30%, but the “flow” or volume from passive selling will overwhelm all other market players. The numbers from the above table are so large it would invite catastrophe.


It Really Doesn’t Work in Reverse

As is the case with McDonald’s, the Big 3 are the top three holders of the company with 153 million shares owned. Just a 2% net outflow would require the immediate sale of 3 million shares of MCD. This is equal to the volume of MCD in one entire trading day! When passive investors sell, will they only be redeeming 2% of their holdings? What about 10, or 25%? Suffering a complete lack of buyers, the Big 3 would be forced to reduce their asking prices to find buyers at any valuation. Remember passive firms conduct zero fundamental research and buy when they receive inflows and sell when they owe outflows. How low will MCD go in order to find buyers for an amount of shares that is potentially larger than any of the other institutions’ holdings? Now, while the market sits at record highs, is an excellent time to ask yourself these questions and prepare for the inevitable outflows from passive investing.