An index isn’t a fiduciary — and six other concerns about the push for passive

We offer a framework for investors grappling with the role of active and passive strategies, taking into account key decision points such as the “zero-sum” argument for passive, the role of market inefficiency, and the possibility of finding an above-average manager.

Views expressed are those of the author and are subject to change. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. For professional or institutional investors only.

Seven concerns about the push for passive

1 An index isn’t a fiduciary

2 The “zero-sum” argument is overblown

3 Cap-weighted indices may not be aligned with investors’ most important goals

4 Passive performance has created a false sense of security

5 There is a reasonable case for market inefficiency

6 An above-average manager isn’t so hard to find

7 The backdrop for active managers and the investors they serve may be improving

“IT IS DIFFICULT TO GET A MAN TO UNDERSTAND SOMETHING, WHEN HIS SALARY DEPENDS UPON HIS NOT UNDERSTANDING IT.” This quote from Upton Sinclair might resonate with proponents of passive investing who find themselves faced with another argument for active management, written by a commentator whose salary is indeed paid for by active management. But mindful of the immense challenges faced by institutional investors today and inspired by my firsthand observation of highly skilled asset managers over more than 20 years, I think it is worth sharing several reasons why I believe active management has a meaningful role to play in investors’ portfolios, even (and perhaps especially) in a world where passive investing may too. I frame this argument through seven concerns that I believe investors must address as they consider how passive and active strategies can help them achieve their investment objectives.

1. An index isn’t a fiduciary
Passive investments based on market-cap-weighted indices have an undeniable appeal. Their costs are low and they are scalable, with the ability, in theory, to hold an infinite amount of capital while preserving the appropriate relative weights between stocks and with limited rebalancing or trading needed over time. (Note that I consider any portfolio that deviates from market-cap weighting to be “active” even if it is based on an “index.” For more on this point, see the sidebar at left.)

But an index is not a fiduciary. An index is defined by a set of rules (or, in some instances, by a committee) that has no specific reference to the interests or constraints of any investor. It defines an opportunity set without asking whether that opportunity set is aligned with the investor’s objective. To put it more bluntly, every investor has a reason for investing, but that reason is not the…

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