The Rise of Passive Investing
Summary of Marc Rubinstein's "Trillions: The Rise of Passive" Article
In August 2019, the amount of money invested in passive funds surpassed the amount of money invested in active funds for the first time ever in the U.S.
In other parts of the world, the amount of funds invested in active funds still exceeds the amount of funds invested in passive funds though, except for Japan, where passive investing makes up 73%.
Here is a very brief history of how it started as told in Marc Rubinstein’s Substack article Trillions: The Rise of Passive.
A fund that would invest an equal amount of money in each of the 1500 stocks on the NYSE was launched by John McQuown and his team in July of 1971.
The trading costs, which were much higher back then than they are today, made John’s fund hard to manage because he and his team had to trade a lot to maintain equal weightings to match the index.
Wells Fargo also launched a fund to mimic an index (the S&P 500) but they had trouble in their early days of raising enough money to allocate it to all of the stocks in the S&P 500.
Batterymarch launched a fund also which struggled in its early years as well.
In summary, the fees on these funds were attractive but it still took some time for investors to feel more comfortable investing in passive funds. Then at the end of 1975, Batterymarch had $100 million and Wells Fargo had $150 million invested in passive.
Things were starting to change.
Paul Samuelson wrote an article titled Challenge to Judgement mentioning that more of these should be started. John Bogle read this article.
John Bogle got fired from the company he was CEO of called Wellington Management for two reasons - assets under management fell by more than half and John just had an unsuccessful merger.
After he got fired, John was able to convince the funds under Wellington’s management to do fund administration duties under a subsidiary called Vanguard with John Bogle as the CEO.
John then noticed the opportunity to setup low-cost index funds based on this new setup he had at Vanguard and after reading Paul Samuelson’s article.
John signed a deal with S&P to license their index. (These licenses that S&P and MSCI have are very valuable because their indexes are so widely used by investment firms when creating etfs)
Vanguard created the First Index Investment Trust in 1976 with a projection that the annual cost to manage the fund would be .50%.
It wasn’t until 1981, 5 years later, that this fund surpassed $100 million in assets under management and then in 1988, 12 years later, this fund surpassed $1 billion in assets under management.
Vanguard became hugely successful as we know today where it manages over $7.2 trillion of assets with expense ratios costing .09%.
Blackrock is bigger than Vanguard though. They manage $9.5 trillion of assets with a third of it allocated to index funds and another third allocated to ETFs.
Passive investing has come a long way to surpassing active investing.
Blackrock, the owner of the iShares, identified five periods of ETF innovation as shown in the image below:
With all of the benefits of passive investing like low costs, Marc mentions two criticisms from Robin Wigglesworth’s new book Trillions: How a Band of Wall Street Renegades Invested the Index Fund and Changed Finance Forever.
Those two criticisms are:
1. There are so many ETFs (8,000) and indices (3 million) around now that picking the right ETF or the right index has gotten too complicated.
2. The passive index industry is distorting markets since they are becoming price makers instead of price takers when the role of price maker should be assigned to active investors.