ETFs, Roboadvisors, and Passive investing causing firms to retain too much risk?

Active investors are well positioned to respond to earnings volatility, increased retained risk, KRI’s and other leading indicators that highlight risk to publicly traded firms.  Are passive investment platforms as well positioned?  If not, are ETFs, Roboadvisors, and Passive investing causing firms to retain too much risk?

If more capital is continuing to flow into the markets in the form of passive investment strategies does the CFO or executive leadership of underlying firms lose sight of protecting earnings volatility?   Or are they encouraged to maintain their position in the index.

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Many asset managers have established passive investment platforms to compete with low fee passive platforms like Vanguard.  But is this shift good for investors, good for firms, etc.  Is it driving behavior changes by management teams?  Hedge funds seem well positioned to benefit from passive investment strategies (dumb money), supporting firms that don’t have the appropriate risk adjusted returns.

As an example, are large insurance companies in the S&P 500 retaining more and more risk due to the fact that their stock price is less sensitive to Key Risk Indicators?  Does this drive less reinsurance purchases and more retained risk?

To expand outside the insurance industry, does this growth in passive investing cause any firm to have same result- retain more risk.  Is this having an impact on industrial, REITs, consumer, or other sectors more than others?  Are they buying less insurance or the larger firms increasing retention to levels that would have negative impact to earnings?   If so – do these firms decide to form single parent or join group captives?

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If this thesis is true, what should insurance companies do with pressure on both sides of the firm (capital/technology)?  Are Insurance firms better off continuing to buy more reinsurance in soft market and protecting earnings volatility – will this firms be rewarded in the stock price?

This is more thinking out-loud rather than any findings.  But I would be interested in hearing your thoughts – please comment below.

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Arnold Smith

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