Passive investing hurts long-term stock ownership, only short-term remains

On the stock market, it is common to mention the importance of long-term holding of securities to take advantage of the strength of compound interest and avoid excessive turnover leading to hefty commissions. But the truth is that the holding of securities has been reduced, there are fewer and fewer “buy and hold” supporters.

Based on current data from the US stock market, the average holding period for US stocks was 5 and a half months in June, up from 8 and a half months at the end of 2019. And it is not something unique to the United States, in Europe follows that line, with holding periods that are reduced to less than 5 months, from the 7 months of last December.

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There are many critics who blame it on the supposed stupidity of the new investors but, as we will see later, the tendency to shorten the holding periods started 50 years ago, not with the new investors or the new generation.

The justification for this fact is multiple. The main one is the increase in passive management, which seems to be a contradiction given the low turnover rates of thepassive funds. And is that passive funds must be rebalanced periodically to faithfully follow the benchmark.

With the rise of lower cost investment vehicles that can be traded as individual stocks, ETF volumes have increased to significant proportions of market activity relative to its size. It appears that this turnover and activity impact underlying securities, offering greater volatility and turnover for shares included within ETF’s amplified by arbitration activity, often impacting sectors, countries, industries, styles, or themes.

And in active management itself we are seeing certain changes. Today fund managers pursue an active allocation of focused assets through ETF’s, rather than the underlying shares themselves.

But there are more factors. The so-called “little machines” of the High-Frequency Trading (HFT) have gained a remarkable operability in the market, both for size and speed. It is estimated that lHFT firms represent more than 50% of all US equity trading volume, 40% of US futures volumes and 40% of US options volumes. In Europe, HFTs represent around 30-40% of volumes in stocks and futures. These fractions have risen from single figures as recently as a few years ago.

High Frequency Volumes Lrg

The lowering of transaction costs, up to zero commissions, is also relevant. Among the different intermediaries we can highlight the role of Robinhood who pioneered commission-free trading, offering both cash and margin accounts. The stockbroker used to advertise that he made money by earning interest on the uninvested portion of client funds. This together with other applications are channeling the entire public millennial.

However, with interest rates set at 0% in 2020, it meant that this strategy was much less profitable. From there opened other business segmentssuch as margin loans, monthly fees for enhanced services, and remortgage that allowed the company to use customer securities to support other financial activities.

This was not always like this

According to the NYSE index data, the average length of the holding period by US investors was around 7 years in 1940 and stayed the same for the next 35 years.

If we look at the 1970s, the investment landscape was largely dominated by wealthy individuals and families.

At the same time, until the early 1970s, stocks were traded with a fixed commission established by the New York Stock Exchange, up to 2% each way (or 4% entry and exit) of the full value of the shares being traded, with additional fees for smaller transactions sometimes double the cost.

In those years, investment funds were developing and, therefore, their degree of availability was limited. Therefore, there was no possibility of trading an entire portfolio in one or two transactions. If you wanted to trade a diversified portfolio, you had to perform costly trades separately for each individual stock.

In the early 1970s, Congress and the US stock regulator required the New York Stock Exchange to phase out fixed fees for the largest transactions, and ended them for all investors in 1975, which opened the door for brokers.

This was followed the explosive growth of investment funds available, thanks to which investors could exchange an entire portfolio with a single phone call, and later with a simple mouse click, without any transaction costs if managed directly with the investment fund.

Number Of Mutual Funds By Year

With these movements, the average holding period had fallen to less than 2 years at the time of the flash crash of ’87. By the turn of the century, had fallen below a year and was around 7 months in 2007.


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