Most would agree that the decline in the number of IPOs is not attributed to any single regulatory or competitive event and that in today’s world of low interest rates and private equity new companies have more alternatives for raising capital thus foregoing the traditional IPO process. But what about the growth of passive investing and its impact on active managers? Is there a connection between later’s demise and our public markets’ ability to be an attractive capital raising alternative for new companies? Has passive investing become so powerful that it has not only marginalized active management, but also capital formation?
Today passive investment styles executed through ETFs and other index vehicles form such an essential part of an investment strategy that they in fact drive both the strategy and the market structure. It is doubtful that the inventor of the first ETF or index product set out to change market structure, but they did. While most of the changes ETFs and index vehicles have provided benefits to investors in the forms of transparency, risk mitigation, access to non-traditional asset classes, trading efficiencies and a range of other areas, they have been by definition disruptive. And as with any disruption, unforeseen consequences have developed which have contributed to the overall degradation of our public markets’ ability to perform its capital formation function.