Terry Smith: Passive Investing: The Self-Reinforcing Momentum Strategy
In his latest letter to shareholders, Terry Smith explained why passive funds are effectively momentum strategies that create a self-reinforcing cycle, driving up large-cap stocks.
In late 2023, passive investments via index funds surpassed active funds in Assets Under Management (AUM), now exceeding 50%. During the Dotcom boom, only 10% of AUM was in passive funds. While index funds are labeled as “passive,” they are effectively momentum strategies, as their market-cap weighting prioritizes large companies that have performed well.
This creates a self-reinforcing cycle, driving up large-cap stocks. However, an economic downturn, particularly in tech spending or AI, could disrupt this cycle.
If major companies underperform,…
