BofA RIC Report : Passive investing at critical mass

BofA RIC Report Feb 2025: Passive investing at critical mass

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The RIC Report Outlook from BofA: where are the customers’ killer apps?

The bull case for equities looks stronger: profits growth is broadening as 89% of stocks are expected to have positive EPS by Q4 and the ISM PMI moved to expansion (>50) for the 1st time since Oct’22. Bear case: great AI expectations of 17-20% EPS growth could falter if training data runs out, macro turns stagflationary, or customers say “enough!”

Passive dominance raises the stakes for investors

Passive funds dominate with 54% market share; since most are market-cap weighted, flows to passive funds exacerbate market concentration (Exhibit 1). Just five stocks comprise >25% of the S&P 500. Systemic concentration raises the stakes: passive disregard for valuations & fundamentals means big upside from innovations (US 11%/yr. vs. RoW 6%/yr since ‘87) but big risk in a bust cycle (Nifty Fifty, dot com).

How passive funds came to power

Passive dominance is a creation of law. Some rules ensure out performance by passive (e.g. the ‘40 Act); others expand demand for equities. The overlooked link to the real economy is that passive flows give market leaders a lower cost of equity, and legalized buybacks help them buy competitors & hire the best labor.

Three things to do about it

High valuation & concentration alone are not good reasons to sell: returns are similar in years with rising & falling concentration, and the US looks better than many others. But watch equal- vs. cap-weighted returns for signs of a shift. Portfolios of high-quality stocks have outperformed passive indexes across market cycles, sometimes with no Mag 7 exposure. Finally, risk management is key: see our interview with Derek Harris about the risk approach that makes his team indifferent to concentration.

Exhibit 1: The third bubble in growth stocks, the first compounded by passive

BofA RIC Report Feb 2025 Exhibit 1
Source: BofA RIC Report, Global Financial Data, Standard and Poor’s, Bloomberg. “New” economy = Tech + Communication Services + Consumer Discretionary

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