Too Big to Fail?

The Sadly Optimal Portfolio Strategy

Abstract

This paper investigates how post-2008 monetary interventions, the rise of ETFs, and the dominance of passive capital flows have reshaped the structural dynamics of U.S. equity markets. Drawing on return distribution asymmetries, rank persistence, and a novel portfolio backtesting framework, we document that market behavior increasingly resembles a mixture of heterogeneous, rank-locked assets under persistent frictions—a sharp departure from the assumptions of efficient markets and no-arbitrage pricing. At the center of this structural shift is the “Too Big to Fail (TBTF) strategy”, which selects the ten largest market-cap stocks and applies a convex internal weighting scheme. Since 2010, TBTF has delivered persistently superior risk-adjusted performance relative to standard benchmarks. Crucially, this outperformance is not explained by fundamentals or factor exposures, but emerges from capital lock-in, index-induced inertia, and structural concentration. The strategy is thus “sadly optimal”- it profits precisely when the market is failing to allocate capital efficiently. If it ceases to work, it would mark a return to allocative discipline—a socially beneficial outcome. The findings challenge the core premises of asset pricing and raise fundamental questions about competition, fairness, and the future role of financial markets in an intervention-driven economy.

1 Key Highlights

Too big to fail? More like too big to be good, too big for justice, and too big to not exploit.

• Structural Distortion and Distributional Asymmetry
  Post-crisis liquidity regimes and passive flows have created persistent advantages for dominant firms. The result is a market characterized by asymmetric return distributions, rank inertia, and the erosion of marginal risk pricing.

• The TBTF Strategy as a Structural Probe
  A simple long-only portfolio of the top 10 firms, weighted convexly, consistently outperforms across risk-adjusted metrics. Its success functions not as evidence of market efficiency, but as a diagnostic of structural misallocation.

• Paradox of Optimality in a Broken System
  TBTF is optimal precisely when markets are not. If it performs, it exposes deep inefficiencies; if it fails, it may herald a return to allocative justice. Either way, the investor wins, while society bears the risk of institutionalized stagnation.

• Implications for Theory and Policy
  The findings call for asset pricing models that move beyond risk–return tradeoffs and incorporate rank-based valuation, non-ergodic dynamics, and mobility constraints. Policymakers must confront the unintended consequences of index-driven capital allocation.