Passive Investing Could Crash the Market, Swiss Re Institute Analysts Warn

The big picture: The institute analysts are predicting that world inflation-adjusted gross domestic product, or overall income, will increase 2.8% in 2025 and 2.7% in 2026, or about as fast as it's growing this year.

World life and annuity premiums could grow about 3% per year.

Factors that could throw off the projections include trade wars and other geopolitical risks, the analysts write.

The U.S. life and annuity markets: U.S. interest rates looked as if they might stay "lower for longer" from about 2009 through 2022, and that hurt U.S. annuity sales.

The Federal Reserve began increasing interest rates in 2022, in an effort to fight inflation, and that helped fixed annuity sales.

Now that rates are coming down, "we expected fixed-rate annuity sales growth to slow and the focus to shift to indexed annuities," the analysts say.

Employers are also continuing to shed pension risk by buying big group annuity sales, and strong sales of annuities used in pension risk transfers could be another source of growth, the analysts say.

The potential passive investing threat: Economists have long argued that dartboards and other random systems do about as well at picking stocks as active investment managers.

Many investors have acted on that view by putting money in passive funds that simply invest in stock indexes, or all of the stocks in an index, or into arrangements such as target-date funds that invest mainly in groups of index funds.

"The total value of passive fund assets surpassed actively managed assets for the first time this year," according to the Swiss Re Institute analysts. "As more investors cluster into a few stocks, and these investors have more inelastic demand amid the rise of passive investing, market efficiency declines further, and reflexivity increases more. However, as long as these sell-offs remain contained and short-lived and do not trigger the default of a larger investment fund or affect the banking channels, systemic risks to the wider real economy should be contained."

But, in a worst-case scenario, "these changes in market structure could amplify sell-offs in response to unexpected exogenous shocks, such as from geopolitics which we see as our top risk to our baseline," the analysts warn. "Financial market volatility has been comparatively low compared to current high and uncertain geopolitical risks. The widening gap between an uncertain geopolitical environment and market volatility heightens the risk of sudden volatility spikes and significant asset repricing should a major shock occur."

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