Tadas Viskanta continues his series on “finance blogger wisdom” today discussing index funds. Specifically, he asks:
Should we care that the percentage of assets in indexes is on the rise, or should we just sit back and enjoy the (low cost) ride?
My answer was, um, not very thorough (again):
Indexing requires active management in order to maintain the “passive” allocation held by the indexers. The rise of indexing is good for both the technologically enabled active market makers and arbitrageurs as well as the passive indexers. It is, however, very bad for the high fee traditional “active” manager.
My views on indexing are simple. If you want low fees, tax efficiency and diversification then indexing is the way to go. As I noted in my new paper, I am an advocate of using market cap weighted index funds inside of a Countercyclical Indexing strategy. In other words, keep it simple, low cost, tax efficient, maintain an adaptive asset allocation across a fairly long time horizon and ensure your risk profile is in-line with your asset allocation as the markets evolve across time. But there’s also a lot of confusion surrounding indexing. For instance:
1 – Stock pickers don’t like indexers and vice versa so there is a mythical line drawn in the sand across the “passive” and “active” battlefield. But there’s a lot more overlap in this battle than people portray. Someone who refers to themselves as a “passive” or “active” investor is like someone who wades into waist deep water and then declares that they’re “wet” or “dry”.¹ That’s not really how that works. The same goes for passive or active investing. Someone who is being passive is reliant on active investors to make markets in the underlying instruments that the index fund owns. Further, there’s a lot more “activity” in a passive approach than some indexers seem to think (deviating from global cap weighting, rebalancing, contributing, distributing, how the actual index is managed beneath the surface, etc). So, there’s a lot more gray area in this discussion than we generally assume.
