This is a natural question given the level of industry discussion and commentary on the topic. These perspectives often cite stats and offer views on the investor dynamics underlying this trend. Regardless of the forum I’m speaking in, I find the audience is sometimes surprised to hear my headline perspective: I believe the trend reflects a new form of active investing, not passive!
This response is often met with inquisitive—and sometimes confused—looks, so allow me to explain. As a researcher, I scrutinize data and assess situations through a variety of lenses. Discussions about the trend toward passive tend to be prompted by the increased market share of index funds relative to that of traditional active funds. And while I would agree that it is best to assess the trend based on aggregate assets, I find this perspective to be a bit limited because it provides insights about individual fund use based on a category (i.e., index or active) that is not highly indicative of investment exposure. To put it simply, the notion overlooks a much more critical perspective—the aggregate investment exposure at the portfolio level.
I’ll use the same extreme example that I use while responding to audience questions to illustrate this point. Suppose an investor states she is “100% passive” because she implements her entire U.S. equity strategy with a small-cap value index fund. Although that might be a 100% allocation to a passive fund, it is not a 100% passive position. Using a small-cap value index fund to implement an allocation to the total U.S. equity market is a highly active position. Whether this is intentional or unintentional isn’t the point, but it would reflect an active allocation.
This chart illustrates my reasoning. If investors aimed to implement a truly passive strategy relative to the total U.S. equity market, they would likely just use funds that have an objective of doing so (noted in the chart as “total market index funds”). However, most of the growth in index fund assets has been driven by investors selecting funds that do not have such an objective (“non-total market index funds”). Investors might be using more and more index funds, but they aren’t building truly passive portfolios.