Data point to increasing diffusion of assets across active U.S. stock funds, which could theoretically make the market more efficient.
The two decades-long explosion in index funds has been well documented. But lost in the shuffle is another somewhat surprising phenomenon—increasing diffusion of assets across funds.
In this article, we’ll review this change and what it might mean for market efficiency.
Explosion of Mutual Fund Assets
There’s no doubt that there’s been a broad shift in equity assets from active to passive options. As of 1997, passive options accounted for 10% of total assets in funds in the U.S. equity mutual fund categories.
As of June 2017, passives stood at 45% of assets and their gains have accelerated in the past few years, as one can see from Figure 1 below.
While this shift of assets from active managers to passive managers has been unfolding, another development in the actively managed subset of the fund universe has not received much, if any, attention. It involves asset concentration. Our interest lies primarily in the fact that, potentially at least, changing levels of asset concentration may have implications for overall stock-market efficiency.
Have Investors Been Spreading Their Bets?
Concentration is easy to grasp intuitively. In the context of assets under management, the more assets are controlled by a handful of funds, relative to the universe of all funds—or assets controlled by a few fund firms relative to all firms—the higher the asset concentration.
To measure that asset concentration, we’ve used the Herfindahl Index, whose advantages are threefold. First, the Herfindahl Index’s scale is easily understood. A Herfindahl index value of 1 means total concentration of the variable in question in one participant; a value of 0 (not really attainable) reflects perfect “diffusion”. Second, it is a relatively well-known, and broadly accepted, tool. The U.S. government uses it to gauge industry competitiveness when evaluating the effects of corporate mergers or takeovers. Third, it has a nice intuitive interpretation: It gives the probability that two randomly selected dollars came from the same source, whether it is a fund or a firm. (I’m using probability in the math notation, where 0 is 0% and 1 is 100%.)