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How Passive Investment Is An Anchor On the Economy and Innovation

Jack Bogle was known as the “Father of Passive Investing”, but upon his death in 2019, he lamented his creation, as it later swung deeply into ETF territory. In fact, his disdain for ETFs was such that he even referred to the folks who traded them as “fruitcakes, nut cases and lunatic fringe.” Tell us how you really feel, Jack!

The road to hell is paved with good intentions

When Bogle created index funds in 1975, he aspired to offer retail investors a cheaper option to get off the sidelines to join the pros in the game. His pioneering model was designed to lower transaction fees and eschew trying to beat the market, by effectively buying the market in order to earn what it makes. Most of us know this buy-and-hold strategy as advice Warren Buffett has been preaching about index funds for decades. However, this strategy results in minimal trading in the market, which has had a long tail effect on the economy and innovation.

Collision course

Like a cord yanked from the wall socket, the data below abruptly ends in 2018. But to the surprise of probably no one looking at this graph, 2019 was the year when passive finally surpassed active funds in the market. According to Morning Star, the end of 2020 even witnessed investors yank more than $250 billion out of active US equity funds. Aaand much to Bogle’s chagrin, ETFs make up nearly 50% of the passive market.

When you own Boardwalk and Park Place

When we talk about passive investing, it’s impossible to ignore the gargantuan index funds. For context, 90% of companies on the S&P 500 can usually point to one of the Big Three — Vanguard, BlackRock, and State Street — as their single largest shareholder, and these three control 80–90% of the market. In fact, it’s even been argued by a Harvard Law professor that we’re on trajectory for a dozen individuals to wield “practical power” over the lion’s share of publicly traded companies in America. Talk about hyperconcentrated control.

At the wheel, on autopilot

With such a large portion of investors just buying and hanging on — as is the nature of index funds — I’ve got to say, this means that either a large part of the market behaves rather lazily or an even larger portion of the possible market hasn’t joined the party yet. The trillions of dollars in this monolith seems to be overwhelmingly decided by complicated algorithms anyways. So there aren’t even hamsters on wheels behind the scenes anymore, buying and selling winners and losers based on daily market information or human emotion. That’s the whole point of a capitalist market though: new players set up shop, new ideas hit shelves and the market reacts accordingly — based on fact or even their own fiction.

Juxtapose laissez-faire index funds against the world of plucky startups (99.7% of small businesses in America) and crowdfunding. This ecosystem is where radical innovation takes place, as these businesses are in constant motion and always innovating, trying to survive and thrive. They’re more nimble and dialed in. Yet (ironically) they have much less capital and potential to move markets. However, here is the good news. Where we all bore witness to the social collusion inspired by GameStop, it was so elegantly proven that by banding together, even the ‘lowly low’ 99% could force stock movement and change the fortunes of the snobs who snub their noses at us. And while it is true that the cost will be a shit ton of Federal ire, they don’t seem to give a shit about the 99% anyway.. and we’ve all been pissed for a long time.

Decrease the incentive to compete

From the perspective of the businesses outside the hyperconcentrated monoliths, it takes the wind out of your sails to create something spectacular and know that it can’t really have much effect on the market. With such a tremendous amount of money parked for the long haul, and impervious to real life market data, there really wouldn’t be much that could derail the trajectory of these funds. What lasting incentive is there to compete now and into the future?

In 2016, a Bernstein investment strategist declared passive investing to be “worse than Marxism” given its inefficient nature. Capitalism is predicated upon competition in a free functioning market, and passive investments seemingly make this a much tougher argument. Society and business don’t benefit from stagnant money squirreled away because it doesn’t innovate or work for the larger public. Index funds are to investors what the default option is to consumers — the easiest option is nothing.

Here we are again

However, the stakes are much higher when trillions of investment dollars do less and end up making more for a small faction of society — it always seems to come to this. This commitment to inertia drags all participants down and limits overall market movement. After decades of passive investing, it seems that we may have underestimated the role those little hamsters have in keeping the market functioning efficiently for everyone. As we can see in the adjacent financial markets, money pumped in has a profound effect on communities, businesses and the entire ecosystem.

Let’s just see if the rest of the world catches on.

Business Management & Financial Services Consultant Focused on Development Stage Companies & Microcap Markets