Indexing Genie is Out of the Bottle - The Road to Serfdom

In August of 2016, the brokerage firm Sanford C. Bernstein & Co., LLC. wrote what may be the only serious criticism of passive index investing that I have ever seen.

(https://www.bloomberg.com/news/articles/2016-08-23/bernstein-passive-investing-is-worse-for-society-than-marxism).

The gist of this article is that despite the utter and total complete investment success of indexing as an investment strategy (almost 1/3rd of all aum when compared to every other strategy) indexing is a threat to capitalism. That is, passive investing "impedes the efficient allocation of capital". The article further states that "the social function of active management ... is to direct capital to its most productive end, facilitating sustainable job creation and a rise in the aggregate standard of living". 

Hurrah! The indexing genie is out of the bottle: indexing or passive investing is a SYSTEMIC RISK!

The most basic systemic risk in finance is anything that is not sensitive to price.  A well functioning capitalist system creates buyers when prices are too low and creates sellers when prices are too high. Unfortunately, passive indexers, like myself, do not have market incentives to buy or sell. We just buy and hold.

So, what's wrong with that? Lots is wrong with that. Passive investing is divorced from price signals. Passive investing is actually a parasite on the back of the remaining active investors. Without active investing, there would be no price signals and no markets. 

As long as the great majority of investors are active, passive works. Passive assets under management, aum, is currently estimated to be just under 30% of all aum. If this number were to grow much beyond 50% there will be fewer and fewer investors left to tame the markets and passive investors will be on a new uncharted road. 

Disclaimer: This blog is not investment advice, is for information purposes only, may be subject to change without notice, and while prepared with care, may be subject to omissions and errors.