Passively managed assets have grown dramatically since the inception of indexing in the 1970s. (Exhibit 1 illustrates this for the S&P 500®, arguably the most widely tracked index in the world.) Unsurprisingly, some active managers, as well as other critics, have raised questions about the impact of the growth of indexing. The charges leveled at index funds include suggestions that they encourage collusive behavior, that they are poor stewards of their customers’ assets, that they contribute to market bubbles, and that they diminish market efficiency. We offer rebuttals to each of these concerns, and suggest how an eventual equilibrium between active and passive assets under management might arise.
Recent years have witnessed a plethora of criticism directed at passive management by the advocates of a more traditional, active approach. To appreciate the extent of these claims, consider the following simple exercise. We performed a Google News search for “danger of passive investing” and found 171,000 news items. A search for “danger of passive smoking” yielded 29,700 news items.1 Yet does any reasonable person believe that index funds are more dangerous than cigarette smoke (which might, after all, actually kill you)?