‘Ponzi funds’ chasing a small number of stocks are inflating asset prices by as much as $500m (£391m) every day a new paper has revealed.
Actively managed funds that hold very few stocks in their portfolios are pushing up the price of stocks above where they should be, the paper from Harvard Business School and Capital Fund Management found.
This artificially strong performance attracts new customers, creating a “feedback look and a reallocation of wealth to early fund investors, which unravels once the price pressure reverts,” it said.
These new investors chasing self-inflated returns predict bubbles in exchange traded funds (ETFs), which track the market, and also can be used to explain crashes in the market.
“Because investors place a higher weight on the most recent return, even short-lived price pressure can have an impact,” the paper stated.
Since 2019, the total cumulative dollars that ETFs have reallocated due to this feedback loop was estimated to be around $440bn (£344bn).
The authors, Philippe van der Beck, Jean-Philippe Bouchaud and Dario Villamaina, added that the underlying drivers of the feedback loop “apply more generally” to other markets, like the $300bn (£235bn) commodities futures market.
“The inability of market participants to distinguish between realised fund returns stemming from fundamental determinants and those driven by price impact has important implications for asset markets,” they concluded.
Ponzi schemes are a type of investment fraud where profits are paid to early investors using money put in by more recent investors, allowing them to maintain the illusion of returns as long as new money is always being put in.
However, economic bubbles are not traditionally considered Ponzi schemes because they do not rely on a central actor misrepresenting the investment scheme.