Three positive consequences of the growth of indexing
- Robin Powell
- Apr 28
- 3 min read
The rise of indexing has been one of the most significant investment trends of the past few decades. While some critics worry it could harm market dynamics, the shift has brought clear and lasting benefits to investors.
According to DR TIM EDWARDS of S&P Dow Jones Indices, there are three key positives that deserve more attention.
Key takeaways
1. Huge savings in fees
Investors moving from high-cost active funds to low-cost index funds are saving enormous sums. S&P Dow Jones estimates that investors tracking just the S&P 500 are saving more than $20 billion a year in fees. These savings compound over time and can significantly boost long-term returns.
2. Improved market efficiency
Contrary to popular belief, indexing has actually made markets more efficient. As underperforming investors and managers give up trying to beat the market and move to index funds, the average skill level among active managers rises. That makes it harder for others to outperform, helping to reduce inefficiencies.
3. Indexing allows for more choice for investors
The growth of indexing has led to an explosion in the number of low-cost index funds available. Investors now have access to a wide range of markets, asset classes and sectors all at much lower cost than traditional funds.
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TRANSCRIPT
Robin Powell: We’ve seen a huge rise in the popularity of indexing in recent years.
Some commentators view it as a negative thing.
But it has had positive consequences.
Dr Tim Edwards, Head of Index Investment Strategy at S&P Dow Jones Indices, points to three benefits in particular that, in his view, are under-appreciated. Here’s the first.
Dr Tim Edwards: You have an increasing number of investors who have saved money on management fees by moving from high fee products into much lower index, fund based products.
We published estimates that, and just to put some dollar figures on this, we are doing an annual estimate of how much money is in index funds tracked in the S&P 500 and how much money is being saved compared to the average investment in an actively managed fund.
And the average fee that that's associated with, the statistics or the figures, are of the order of over $20 billion a year saved in fees.
RP: That is clearly a huge amount.. And remember, that’s just one index, the S&P 500.
The second positive consequence of the growth of indexing, Dr Edwards says, is that it has made markets more efficient — in other words, the very opposite of what many commentators have suggested.
Here’s his explanation.
TE: Who are these people who are buying index funds? In some cases, they will be people who have been disappointed by their own performance, trying to beat the market or the appointments of the agents or managers that they have that they appointed.
And if you do believe or if you do you think there is some aspect of skill involved, then what that means is those who were underperforming, those who were unskilled are no longer providing the market with the opportunity to exploit them, because they are just now following the market average.
They're getting the average. They are no longer below average. A consequence of that means it is harder for the remaining active managers to outperform. The average intelligence just went up.
The average skill went up, the average performance went up. So being above average just got harder.
RP: So, the indexing revolution has saved investors a fortune in fees.
It has also made markets more efficient.
But, says Dr Edwards, there’s a third major benefit too, namely a wider range of investment options for indexers.
TE: The choice of indices and markets, which are available in terms of an index option or an index function, has broadened tremendously. So nowadays there is a very broad menu of different asset classes, different segments of the markets for which there is a low cost index fund alternative.
RP: Of course, the rising popularity of index funds has been bad news for active fund managers.
But it’s hard to argue that, generally speaking, it hasn’t been good news for investors.
