Index Funds Will Be Fine

A recent Bloomberg article by columnist Barry Ritholtz argues that, despite the maturation in index investing and a slowdown in inflows to passive funds, “indexing is still giving active funds plenty of competition.”

The decade following the financial crisis, writes Ritholtz, saw “rivers of money gushing into the three biggest indexers” (Vanguard, BlackRock and State Street), and were often explained by fear-based arguments such as indexing was Marxist or Socialist or even dangerous to the economy.

Ritholtz debunks these as misinformed, instead arguing that the shift toward indexing is due to:

  • Changing business models in the money management business;
  • Investors failing to get gains promised by many active managers;
  • Investors becoming disillusioned by “a series of accounting frauds, analyst scandals, scams and Ponzi schemes in the 2000s”;
  • “A sense that markets were rigged against the little guy”;
  • Concepts of behavioral economics that convinced many they lacked the skills and temperament to manage their own money;
  • Market volatility in equities, commodities and housing that “finally exhausted the patience of a generation of investors.”

Ritholtz offers this explanation for the slowdown in index investing: “It has slowed down because the first phase of transition to indexing has been completed. The low-hanging fruit has been picked. If my thesis is correct, after this, inflows will likely be steady but somewhat slower.”