Should the growth of indexing concern investors?
- Robin Powell
- Feb 14
- 3 min read
The popularity of indexing has grown dramatically in recent years. Some financial commentators even claim we are heading for an indexing bubble.
But according to TIM EDWARDS from S&P Dow Jones Indices, such fears are misplaced.
Investing passively simply means holding a broad market portfolio. It does not distort markets or inflate prices artificially.
KEY TAKEAWAYS
1. Indexing reflects the market, it does not distort it
Passive funds allocate capital according to each stock’s market size. Smaller companies receive less money, larger ones more. This market-tracking approach does not favour any one asset unfairly.
2. Passive investing is not driving bubbles
There is no evidence that indexing has caused any speculative bubbles. While markets do experience volatility, broad-based index investing has not been the trigger.
3. Index funds passed the Covid stress test
During the Covid-19 shock in 2020, most passive investors did not panic. Markets stayed functional, and index funds helped facilitate major reallocations without instability.
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TRANSCRIPT
Robin Powell: Index investing has grown hugely in popularity over the years.
In fact, some commentators are warning there’s an index investing bubble.
But Tim Edwards from S&P Dow Jones Indices says that’s somewhat missing the point.
Tim Edwards: Passive investing, by definition, is whole market investing.
You're not putting more money in Apple or in Microsoft or in any other stock, compared to its capacity to absorb your investment.
So smaller stocks get a smaller bit of your money. Bigger stocks get a bigger part of your money. So bubbles certainly exist in stock markets.
They're easiest to spot in hindsight, but there's no evidence that broad based passive investing is what's driving them.
And in fact, it's very difficult to see that happening.
RP: Just to clarify, all equity investing is intrinsically risky. But that is unconnected with the growth of indexing.
TE: Of course, it's a very different question.
There are today or tomorrow. Are equities in total overvalued? If they are, it's not because of passive investors.
All the passive investors are doing is they're tracking the whole market.
And if you are a passive investor, you shouldn't be worried about more people following the same strategy that you are.
RP: Another concern that’s been expressed about the growth of passive ETFs in particular is that, because they’re liquid investment vehicles that can be traded quickly and easily, investors will be tempted to rush for the exits when markets fall sharply.
But that’s not what happened in March 2020, for example, when stock prices plummeted as news emerged about the Covid-19 pandemic.
TE: Well, in hindsight, I think we can make a couple of observations.
The first is that passive investors themselves didn't rush for the exits. And in fact, this shouldn't be surprising because many passive investors are there for the long term rather than trying to time the market.
The second thing that we noticed was again, towards volatility.
It was tougher trading conditions, but overall the markets didn't break.
It kept functioning. And in fact, what we saw was an incredibly astonishing amount of capital being transferred, being reallocated, being readjusted as institutional investors and active managers adjusted their exposures.
Many of them used index products in order to do that.
And overall, I think in hindsight we can say the system really worked and dealt with an extraordinary volatility and change in news flow, very effectively.
RP: So, yes, there have been scare stories about passive investing. But they don’t stand up to close scrutiny.
There’s no evidence yet that indexing poses a systemic problem, or that index investors are exposed to any more risk than investors using actively managed funds.
