The number of Large Cap Blend Exchange Traded Funds holding a deal stock dropped 40% in the two months after the announcement.
Most investment bankers don’t know that deal stocks can struggle not because investors reject transactions but because they skew from benchmarks – and lose ETF flows.
All ETFs whether classed as active or passive depend on a statistical “basket” of securities for prices. That basket needs to behave predictably. Deal stocks don’t (neither do stocks at earnings, by the way).
And Passive Large Cap Blend as an investment category is the single largest equity category, encompassing nearly 70% of all equity assets. Most stocks in retirement accounts aren’t picked for their fundamentals – business performance, return on assets or equity, and so on. They’re chosen for size, liquidity, matching a measure like the S&P 500.
Sure, there are catalyst stocks like AI, quantum computing, at times those in cryptocurrencies, maybe nuclear energy, space, defense. But less than 1% of stocks at any given time “deliver alpha.”
I’ll use a favorite anecdote. Veteran stock-picker and value investor Ron Baron said a half-decade ago in a CNBC appearance that he’d owned 2,500 stocks since starting the firm in 1983. “Take 15 of them out, and I’m average,” he said.
Less than 1% of stocks set Mr. Baron apart from the benchmark.
Public companies, your “addressable market” is the dollars flowing to stocks. What is that money buying? We’re taught in the investor-relations profession how to understand valuation models. We’re taught how to target investors who might like our story, financial returns, position in the market, capacity to deliver growth or value.
We’re not taught how to position our stocks as products for consumption by Passive models – which have all the money now (we can help you!).
Active managers have been net sellers for 15 years. That is, more money leaves every year – to the tune of $400-$500 billion – than arrives. Consequently, Active assets under management are now down to less than 40% of the total.
Blackrock is going the other direction, adding $700 billion in 2025, pushing total managed assets past $14 trillion. A big part of that is US equities.
How do you capture more of that, public companies? For one, by getting bigger. The more space you occupy on the “shelf” in the grocery store called the stock market, the better your chances of capturing flows.
It’s math. Of the 4,400 Exchange Traded Funds for sale in the US stock market, 2,400 tie to domestic equities. And 90% of ETF assets are in large caps. There are about 500 stocks with market cap of $20 billion or more. They’re about 90% of market cap.
Not coincidentally, the S&P 500 is about 90% of market cap because it’s large caps. Get down to the 130 or so with more than $100 billion of market cap, and you’ve got 75% of total market cap.
No matter how those ETFs claim to diversify exposure, they don’t. All rely on the same stocks. It’s why any apparent “broadening” in the market has limited follow-through. Blackrock can’t trade 100 large caps for two thousand small caps.
As I’ve said before, that would be like pouring water from a bucket into a thimble. The market would go haywire. The Russell 2000 is about 3% of market cap. Volatility is more than twice as high in small caps. Liquidity is nonexistent.
The average S&P 500 stock trades 80,000 times per day, $20,000 per trade, $1.5 billion of dollar-flow daily, over six million shares daily.
Small caps have a tiny fraction of those metrics. The lesson for public companies is to get bigger. Use the power of the public market to grow into a large cap.
The lesson for investors is you go where the money is. You can’t do Peter Lynch today and find undiscovered stocks. You’ve got to own the stocks that Passives do, get out when they leave. We see it in Demand and Supply at EDGE, our decision-support platform.
Speaking of getting out, why are European tariffs or Greenland or whatever bringing tumult back to the market when they didn’t before?
I submit it’s because Passives are trying to rebalance holdings without tipping the market over. It started at November options-expirations. Massive increase in Passive patterns.
Add Market Structure Context: New options for February expiration traded yesterday. VIX options expire today. Sentiment is topped, Short Volume is more than 50% of total volume.
What to do, public companies? Deals. Yes, in the short run you’ll lose ETFs, as we have observed. But in the long run you’ll get them back at maybe double the pace.
The problem to solve is a simple but large one: Blackrock et al need more “products” called equities to reduce concentration risk. But IPOs don’t do it. Public companies using equity as currency are the solution.
We can help you build a strategy, public companies. And investors? EDGE (to paraphrase Peter Frampton) shows you the way.
