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The indexation wave
What if index-tracking becomes the dominant form of investment?
Rarely has the cost of investing come under such scrutiny. And rarely with such sustained intensity. With most active equity portfolios having failed to beat their benchmarks since the 2008 debt crisis, regulators and investment consultants seem to have lost patience with the large number of funds whose persistent underperformance is matched by their persistently high fees.
So too has the financial press. The growing disillusionment with actively managed funds and investment gatekeepers’ focus on cost are transforming the financial landscape. Passive investing is firmly in the ascendancy.
Since the end of 2007, passive exchange-traded funds (ETFs) have accumulated a net USD1.7 trillion of investment inflows. That contrasts with the USD1.2 trillion drained from actively managed vehicles over the same period. From the perspective of an individual investor, the shift makes sense. Index-tracking funds charge lower fees. And it is also true that they have delivered better returns than the average actively fund after investment charges.1
Problems are sure to arise, though, if indexation becomes the dominant form of investment. In such a scenario, it is not clear whether the financial market will be able to allocate capital efficiently. Nor is it certain that corporate executives will be held to account. There is also the prospect of entire industries falling under the control of just a few passive investment firms – a development that could erode the pillars of the free-market economy and stifle innovation.
The enthusiasm for index-tracking is born out of regulators’ and consultants’ desire to control cost. That is a laudable goal. But the longer-term costs that will emerge from the continued expansion of passive investment have not been properly assessed. If the majority of investors embrace them, index-trackers threaten to sabotage the very system upon which they were built.
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This document is used for informational purposes only and does not constitute, on Pictet Asset Management part, an offer to buy or sell solicitation or investment advice. It has been established on the basis of data, projections, forecasts, anticipations and hypothesis which are subjective. Its analysis and conclusions are the expression of an opinion, based on available data at a specific date. The effective evolution of the economic variables and values of the financial markets could be significantly different from the indications communicated in this document.
Information, opinions and estimates contained in this document reflect a judgment at the original date of publication and are subject to change without notice. Pictet Asset Management has not taken any steps to ensure that the securities referred to in this document are suitable for any particular investor and this document is not to be relied upon in substitution for the exercise of independent judgment. Tax treatment depends on the individual circumstances of each investor and may be subject to change in the future. Before making any investment decision, investors are recommended to ascertain if this investment is suitable for them in light of their financial knowledge and experience, investment goals and financial situation, or to obtain specific advice from an industry professional.
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For US investors, Shares sold in the United States or to US Persons will only be sold in private placements to accredited investors pursuant to exemptions from SEC registration under the Section 4(2) and Regulation D private placement exemptions under the 1933 Act and qualified clients as defined under the 1940 Act. The Shares of the Pictet funds have not been registered under the 1933 Act and may not, except in transactions which do not violate United States securities laws, be directly or indirectly offered or sold in the United States or to any US Person. The Management Fund Companies of the Pictet Group will not be registered under the 1940 Act.
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