Index funds: Sleepwalking through the stock market
A prominent Wall Street figure says index funds have “fundamentally broken” the market, said William Watts in Market Watch. Last year marked a milestone in the investment world: For the first time, passive investment products—funds that follow the performance of a stock index—held more assets than their actively managed counterparts, which analyze individual stocks to guide their choices. Research has repeatedly confirmed the benefits for most investors of owning index funds rather than picking individual stocks. But David Einhorn of Greenlight Capital says too many investors today “have no opinion about value” because they “assume everybody else has done the work.” Fewer investors even pay attention to earnings, he says, lending a feeling of “complete apathy” to much of the market. And the takeover by passive investing, Einhorn adds, has “completely annihilated” value investors who seek out the underestimated individual stocks.
A market doesn’t work if everyone just “sits back and watches their money grow,” said Katie Martin in the Financial Times. It sounds “a little snobbish” to rail against passive investing, “which has unlocked wealth for millions of people who otherwise might not be active in financial markets at all.” But several recent studies have found that indexed stocks have begun to “show lower sensitivity” even to major economic shocks than their nonindexed counterparts. That turns investing from a process of “seeking out, rewarding, and profiting from successful companies” to a “circular bet” on more money flowing into the market.
“It seems more likely that active management is broken,” said Spencer Jakab in The Wall Street Journal. If Einhorn and other critics are right, “then today’s famine for investing based on value will be tomorrow’s feast.” Active-fund managers, who are supposed to revel in market inefficiencies, should see the passive shift as an opportunity rather than an obstacle. Apparently, some seem to, said the Financial Times in an editorial. There are more hedge funds active today (30,000) than Burger King outlets (18,700). Active traders shouldn’t complain that investors are switching to easier index strategies. “They must prove they can actually make money.”
People have worried about the growing “herd” mentality for decades, said John Rekenthaler in Morningstar. It used to be that brokers fretted about the rise of indexing. “If they couldn’t offer their customers something better than the obvious investments, who would need their services?” Turns out, the financial advice industry hasn’t skipped a beat. The industry adapted to offer better service, not stock picks. Today’s financial advisers are, on average, superior to those of 35 years ago, and index funds played a critical role in that. Advisers and their clients are better off.