Bloomberg Opinion columnist Allison Schrager recently highlighted the enduring challenge of outperforming the market through individual stock picking, reinforcing the foundational argument for passive index fund investing. However, Schrager also raised a critical question regarding the methodology by which these increasingly dominant funds select their constituent stocks, signaling a potential shift in the nature of passive investment.
"It's very hard to beat the market by picking stocks, which has always been the best case for investing in passive index funds. But how should the funds pick stocks?" Allison Schrager stated in a recent tweet. This perspective underscores the long-held belief that markets are generally efficient, making it difficult for active managers to consistently generate alpha. Passive funds offer diversification and lower costs by tracking broad market indices like the S&P 500.
The rise of passive investing has been significant, with the share of money in passive funds surpassing 50% of total investments as of January, a substantial increase from 30-40% in 2010. This trend reflects a widespread adoption of a strategy that prioritizes broad market exposure over active stock selection. Schrager, a senior fellow at the Manhattan Institute, has consistently advocated for index funds in her work, including articles such as "Do Passive Investors Make Markets Less Efficient? The Answer Is No."
However, the definition of "passive" is becoming more complex. Schrager's recent Bloomberg Opinion piece, "SpaceX in Index Funds: Are We All Active Investors Now?", delves into the evolving criteria for index inclusion. She notes that indices like the S&P 500 do not simply include the 500 largest companies; they apply specific standards, such as profitability, which can lead to the exclusion of significant private entities like SpaceX even after they become publicly traded.
This nuanced approach to index construction means that decisions about what to include or exclude are becoming more consequential. The market has seen a trend of companies going public later, often larger and less profitable at their IPOs, which challenges traditional index methodologies. Such judgments, Schrager suggests, may necessitate more research and talent from index providers, potentially leading to increased fees, even if still lower than those of active managers.
Despite these evolving complexities, Schrager maintains her conviction in index funds. She argues that while the "passive" label might require re-evaluation, they remain a superior investment vehicle compared to the often-fruitless endeavor of attempting to beat the market through individual stock selection. The debate now centers on ensuring these funds continue to serve investors effectively as market dynamics and company structures evolve.
