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Is Passive Investing Really Worse Than Marxism?

Analysts at research and brokerage firm Sanford C. Bernstein & Co., the New York-based unit of AllianceBernstein, said this week in a note quoted by Bloomberg that "passive investing is worse than Marxism."

The authors argued that the proliferation of passive investing would, in fact, threaten the very fabric of capitalism. The provocative statement said, according to Bloomberg, that “a supposedly capitalist economy where the only investment is passive is worse than either a centrally planned economy or an economy with active market led capital management."

The majority of the 1,900-plus U.S.-listed ETFs today are passive, index-based products. What’s more, roughly 99% of the $2.4 trillion in ETF assets in the U.S. are tied to passive strategies. Active management in the ETF space remains small, and struggling to gather traction.

So we asked some notable experts in the ETF space: Is the proliferation of index investing bad for markets and investors?

Here’s what they had to say:

Allan Roth, founder, Wealth Logic, an hourly based financial planning and investment advisory firm

I read [this piece] and found it very similar to the poster that came out nearly 40 years ago just after Jack Bogle launched the first index mutual fund. A $16,219 investment 40 years ago is worth over $1 million now. (The actual poster hanging in Bogle’s office is below).

(Photo courtesy of Allan Roth)

While I admit I never thought 40% of money in U.S. stock funds would ever be in index funds, I’m positive that true market-cap indexing can’t become too large. Human nature would take over, and I’d even turn to active investing.

Of course, Bernstein wants lawmakers to create an unlevel playing field to give [active managers] a fighting chance, but that would obviously hurt consumers. The proliferation of indexing is a huge win for investors, and there’s plenty of money still active and keeping markets efficient. Bernstein has a point when they wrote:

" … may wish to consider the broader benefits of a functioning active asset management industry to society as a whole so that when policy initiatives are undertaken they do not explicitly undermine active management."

Bernstein and active managers do provide a valuable service—without them keeping markets efficient, consumers wouldn’t be able to index. While I appreciate Bernstein keeping markets efficient, I strongly disagree with its plea to get an unlevel playing field. They’ve profited enough, in my book.

Wesley Gray, CEO and CIO, Alpha Architect, an issuer of actively managed ETFs as well as a firm that offers tactical asset allocation

I think competition from index proliferation has increased the availability of affordable, transparent and process-driven portfolios for retail investors—all great news for tax-sensitive, long-horizon, independent investors. However, lower costs and easier access to more investment options may encourage excess trading and performance-chasing. So, on net, the benefits are not entirely clear.

Andrew Gogerty, vice president of Investment Strategies, Newfound Research

The active versus passive argument is a simple choice of risk. The rise of indexing is the manifestation of participants’ desire to accept a higher probability of marketlike returns with smaller variation compared with the possibility of material outperformance. Risk cannot be destroyed by diversification; it’s simply an ordering of priority and magnitude of risk exposure by an investor.

Active and passive are inevitably linked. Active works to maintain relative valuations and prices in the market. If those active managers, in aggregate, do a poor job, then passive investors are at their mercy. The Nifty Fifty era and the dot-com days are prime examples.

The two philosophies are further linked. Even in fully passive portfolio, there are multiple active decisions being made with regard to asset- and subasset class allocation, allocation changes, and frequency and nature of rebalancing.

Contact Cinthia Murphy at cmurphy@etf.com.

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