The FT ran a story this week asking if we’ve hit “peak passive.” Similar to peak oil, peak “X” refers to an asset class hitting a sort of critical mass or market saturation. It also vaguely implies that there is no more room to grow and down is the only direction possible. With millions of investors relying on portfolios of passive index ETFs, this could be a mass catastrophe in the making. Or is it? Let’s take an objective look at the perils and possibilities of passive.
Planting the seeds of doubt
Active management fund fees are significantly higher than the fees of their indexing counterparts, so there is profit potential for active managers when passive doubt develops. Active managers have been trying to sow this doubt for decades.
Here’s an example. This week marks the 42nd birthday of the first S&P 500 fund by Vanguard. When it was launched, Fidelity founder Ned Johnson said, “I can’t believe that the great mass of investors are going to be satisfied with an ultimate goal of just achieving average returns.” The semantics in play here are important. Johnson tried to paint “average” as bad. However, that particular S&P fund has compounded at 11.06% per year for the past 10 years, outpacing Fidelity’s flagship Magellan fund’s 9.78% return over the same period. (Data from Bloomberg).
It turns out millions of investors have indeed been completely satisfied to reap the benefits of owning broad market indexes, especially with lower fees, and often, better performance than active alternatives. Why wouldn’t they?
Passive isn’t as passive as it sounds
Proxy votes are another example. Two major institutional holders of Tesla stock are Blackrock and Vanguard, via their passive products. Blackrock recently voted to remove Elon Musk as CEO while Vanguard voted for him to stay. Passive managers hold the rights to proxy vote on behalf of the passive holders. That decision to hold or fold on Elon is effectively an active decision that will have a large impact on the price of TSLA.
Same same, but different
By and large, active mutual funds hold the same stocks as the index funds, just at different and more fluid weights. This is why many active funds have been accused for decades of “closet indexing.” When an index fund collapses or “pops,” the underlying stocks are the source of the losses, not the index structure. In that case, active funds holding those same stocks suffer, too. Stock values determine the value of passive funds, not the other way around. The “peak” argument just doesn’t follow the logic of the markets.
The goal of this article is to add context to an increasingly “anti-passive” news cycle. Keep in mind that many critics of passive have a financial incentive to stir up doubt. This is by no means a comprehensive report on the merits of active vs. passive as it relates to all markets and asset classes. We invite the conversation if you would like to discuss what it means to your personal investments. We’re here to answer the question, “What does this mean for me?”
This communication may include forward-looking statements. All statements other than statements of historical fact are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements.”
“Historical performance is not indicative of future results. The investment return will fluctuate with market conditions.
Past performance is not indicative of any specific investment or future results. Views regarding the economy, securities markets or other specialized areas, like all predictors of future events, cannot be guaranteed to be accurate and may result in economic loss to the investor.
Investment strategies, philosophies, allocations and holdings are subject to change without prior notice.
This communication is intended to provide general information only and should not be construed as an offer of specifically tailored individualized advice.
While the Adviser believes the outside data sources cited to be credible, it has not independently verified the correctness of any of their inputs or calculations and, therefore, does not warranty the accuracy of any third-party sources or information.
Adviser does not endorse the statements, services or performance of any third-party vendor.
Unless stated otherwise, any mention of specific securities or investments is for hypothetical and illustrative purposes only. Adviser’s clients may or may not hold the securities discussed in their portfolios. Adviser makes no representations that any of the securities discussed have been or will be profitable.
Any IPO alerts are purely informational and should not be construed as recommendations to invest.
Any case studies or hypothetical client profiles are for demonstration purposes only. They illustrate the breadth and depth of the many clients we represent at various life stages. Any similarities to actual Adviser’s clients past or present are strictly coincidental. Individual advice and results will vary based on each client’s circumstances, objectives and prevailing economic conditions.