As part of our continued effort to share insights from our events, we are pleased to present an article written by Jean-François Boulier, member of the Inquire Europe Board, for Option France, reflecting on our recent Autumn Seminar in Utrecht.
The growth of ETFs of all kinds, passive or active, and on all types of assets continues. It started in the USA about twenty years ago and has reached such a magnitude that the question of its potential influence on financial markets, in terms of instruments but also valuation is on the agenda. While in the early 1990s passive funds represented only half a percent of the stock market, index funds alone would now represent (according to ICI) more than 16% of the American stock market and its influence through benchmarked funds would be practically a third of the demand for listed securities. This was the theme of the recent Inquire Europe seminar in Utrecht, which made it possible to take stock, thanks to several analyses by researchers, mainly American, of the impacts of the different categories of ETFs on their respective markets, stocks or bonds.
During this seminar, several of the classic impacts of passive strategies were discussed, focusing demand on securities in indices and decreasing in return that of those that do not appear in them. In the case of bond funds grouped into maturity brackets, ETF growth pushes prices on the edge of upper maturities just before securities are included in the portfolios that replicate the index. These effects are far from negligible and could have the effect of inflating bond prices. For example, the analysis shows that as prices become higher, rates offered become more attractive and as a result issuers tend to prefer bonds to bank loans, at least for these maturities. Since the securities of the most replicated indices are together, their specific risks tend to decrease relative to the risks related to the index.
Undoubtedly the most notable and most disruptive effect is the impact in stock prices. Several researchers had already reported this, but the magnitude of the phenomenon has stimulated more recent theoretical and empirical work. The presentation of Dimitri Vayanos of the London School of Economics is in this respect edifying. It establishes the link between the flows towards passive management and the market equilibrium of stocks, effectively taking into account the buying pressure towards the securities with the largest capitalizations. His empirical tests tend to confirm the momentum effect on what he calls “mega stocks”. By analyzing the effect of quarterly flows to passive management over the period 1999 to 2024, he shows that the momentum effect is positive on the SP500 index securities, and that it increases with their size. The two hundred largest values would have a quarterly performance bonus of 0.08% relative to the index; the 100 largest a bonus of 0.17% and the 10 largest of 0.38%… The cumulative effect over the last 25 years would bring an increase in performance of 29% compared to the index for these ten largest American values and even 45% if we take into account the capitalization effects!
Other adverse effects, the volatilities of these “mega stocks” tend to increase and their higher demand tends to make them lose liquidity, because by remaining permanently held they would be less easily negotiable. These effects will last as long as the flows to passive management continue. It also seems according to the work of Laura Starks that the launch of an ETF on the basis of a previously existing fund, passive or active, tends not to cannibalize the fund replicated by the ETF because marketing expenses and new customers thus approached do not modify the existing customer base of the pre-existing fund.
Are such effects undesirable? To avoid them, should we modify the composition of the indices, for example by applying limits to the weight of the securities? In any case, the market reputed to be the largest and safest in the world thus appears to be under the well-known effect of “teatle”, and therefore somewhat far from the efficiency that some attribute to it.
Passive Investing and the Rise of Mega Firms, Hao Jiang, Dimitri Vayanos and Lu Zheng, Inquire Europe Seminar October 2025
ETFs, Mutual Funds and Investors Flows, Laura Starks, Inquire Europe Seminar October 2025