Indexers have no more reason to fear a correction than anyone else

Posted by Robin Powell on August 16, 2018

I sometimes wonder whether it’s a deliberate ploy by the active fund industry to keep trotting out the same old myths about passive investing so many times that we eventually just assume they’re true.

A case in point is the notion that passive investors will be worse hit than active investors by a stock market crash or correction.

The claim was made again last week in a largely circulated article by Ian King in The Times entitled, The risks of passive funds will be cruelly exposed in any correction, which I’m afraid is now hidden behind a paywall.

The article was shared many times by active managers, including Martin Gilbert, the CEO of Britain’s largest fund house, Standard Life Aberdeen.

I actually find it refreshing that this particular article was written not by an active manager, as most scare stories about indexing are, but by a fellow journalist; Ian King is a distinguished former colleague of mine at Sky News.

The argument, though, with respect to Ian and Martin, is complete and utter nonsense. Barry Ritholtz explains why in more detail in his latest opinion piece for Bloomberg, which I would encourage you to read in full, but, in a nutshell:

— the underlying stocks held in index funds are the same stocks held by active managers;

— in previous market downturns active funds have fallen in value just as much as index funds, if not more so;

— passive managers aren’t vulnerable to the same emotions and behavioural biases as active managers when prices tumble because they simply track the market; and

— although passive investors themselves are prone to bail out, the experience of previous downturns has been that active investors have behaved far worse (during the 2008 credit crunch, for instance, passive investors became net buyers of equities, while active investors became net sellers).

Barry makes an interesting point in his article, namely that he expects the antipathy to index funds to abate over time, as people become more used to them. “Just by way of background,” he says “(Ian King) is British, and index funds have a much shorter history and track record there than in the US. I suppose it is natural to fear what we do not fully understand.”

Actually, Barry is both right and wrong there. Index funds have in fact been around for more than 30 years in Britain — Legal & General and Barclays were the first firms to offer them — and they’ve been widely used in the institutional space for much of that time.

It is true, however, that for various reasons, the active fund industry is in a much more dominant position in the UK than it is in the US, and there is much less awareness among the financial media and financial advisers of the benefits of using low-cost passive funds.

I agree with Barry that, as index funds become increasingly popular in the Britain, with no ill effects on investor behaviour, financial markets or the allocation of capital, journalists and advisers will become more favourably disposed towards them. They will also become more sceptical, I expect, of some of the claims made by active managers, brokers and investment consultants.

Who knows? Perhaps one day we can finally knock this passive investing Armageddon story on the head once and for all.

 

ROBIN POWELL is the founder and editor of The Evidence-Based Investor. A freelance journalist, he runs Regis Media, a specialist content marketing consultancy for financial advice firms around the world. You can follow him on Twitter and on LinkedIn.

Robin Powell

Robin is a journalist and campaigner for positive change in global investing. He runs Regis Media, a niche provider of content marketing for financial advice firms with an evidence-based investment philosophy. He also works as a consultant to other disruptive firms in the investing sector.

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