The Wall Street Journal had a series of articles on its web site on October 17 with headlines such as “The Dying Business of Picking Stocks” and “Index Funds are Taking Over the S&P 500.” The articles detailed the now well-known increase in the number of dollars being invested in stock indexes instead of active stock picking. I thought this would be a good time to review some other points.
First, index investing isn’t passive investing. The stocks that make up an index and their weightings in the index change over time and are determined by people making active decisions. Though an index portfolio doesn’t change as often as many active portfolios, it isn’t passive investing. Here’s a link on that issue.
That leads naturally to the second point of why so many active stock managers don’t beat the indexes compiled by what really are other active stock managers. This article takes a view contrary to the most-repeated explanations. It’s not the fees and costs that give indexes their edge. Instead, the researcher’s conclusion is that there are many stock pickers who are more skilled than those compiling the indexes, but the stock pickers or the companies that employ them make decisions, usually business decisions, that sabotage their performance. They allow assets under management to become too large, try not to appear too different from the indexes, and make other mistakes.
You also might want to visit Philosophical Economics blog and review a series of articles posted in the Spring that refutes all the arguments made by those who fear that too much money in indexed investing will cause systemic problems for the markets.
You also might be interested in this academic paper that found the three largest index fund firms between them own 40% of all publicly-issued stock in the U.S.