Skip to Content

A new form of active?

Commentary by James J. Rowley Jr., CFA

In my role as Global Head of Investor Research, I enjoy participating in various industry conferences, policy forums, and client engagements. Over the past few years, I’m frequently asked at these events about “the trend toward passive.” This is a natural question given the level of industry discussion and commentary on the topic. These perspectives often cite stats and offer views on the investor dynamics underlying this trend. Regardless of the forum I’m speaking in, I find the audience is sometimes surprised to hear my headline perspective: I believe the trend reflects a new form of active investing, not passive! 

This response is often met with inquisitive—and sometimes confused—looks, so allow me to explain. As a researcher, I scrutinize data and assess situations through a variety of lenses. Discussions about the trend toward passive tend to be prompted by the increased market share of index funds relative to that of traditional active funds. And while I would agree that it is best to assess the trend based on aggregate assets, I find this perspective to be a bit limited because it provides insights about individual fund use based on a category (i.e., index or active) that is not highly indicative of investment exposure. To put it simply, the notion overlooks a much more critical perspective—the aggregate investment exposure at the portfolio level. 

I’ll use the same extreme example that I use while responding to audience questions to illustrate this point. Suppose an investor states she is “100% passive” because she implements her entire U.S. equity strategy with a small-cap value index fund. Although that might be a 100% allocation to a passive fund, it is not a 100% passive position. Using a small-cap value index fund to implement an allocation to the total U.S. equity market is a highly active position. Whether this is intentional or unintentional isn’t the point, but it would reflect an active allocation.

This chart illustrates my reasoning. If investors aimed to implement a truly passive strategy relative to the total U.S. equity market, they would likely just use funds that have an objective of doing so (noted in the chart as “total market index funds”). However, most of the growth in index fund assets has been driven by investors selecting funds that do not have such an objective (“non-total market index funds”). Investors might be using more and more index funds, but they aren’t building truly passive portfolios.

Non-total market index funds capture the majority of index fund assets 

Notes: The chart shows the development of assets under management in the categories of non-total market index funds, total market index funds, and active funds. Time period observed: January 1995 to December 2020.

Sources: Vanguard calculations, based on data from Morningstar, Inc.

To address this trend, my colleagues and I contributed new research to The Journal of Beta Investment Strategies called “How Investors Use Passive for Active.” We provide detailed evidence that non-total market index fund investors seem to be active in nature. Technically speaking, we find nontrivial variability of excess returns relative to the total U.S. equity market, statistically significant style factor exposures, and industry-level asset weights that are not market-capitalization-proportional to the total U.S. equity market. Casually speaking, it just means that the aggregate portfolio of index funds isn’t passive relative to the market—it’s active.

In addition to making explicit the phenomenon that investors are using passive funds to build active portfolios, our research underscores the importance of analyzing investment strategies as opposed to relying on categorical labels such as “index” or “active.” So the next time you’re engaged in a conversation about “the trend toward passive,” you too can offer your audience a different lens: At its core, this may very well be a trend in active investing. 

Notes:

All investing is subject to risk, including the possible loss of the money you invest.

Diversification does not ensure a profit or protect against a loss.

Your use of this site signifies that you accept our terms and conditions of use and privacy policy.

© 2022 VIGM, S.A. DE C.V. Asesor en Inversiones Independiente (“Vanguard Mexico”). All rights reserved.

This website is for institutional and sophisticated investors only. Vanguard Mexico will not have any responsibility for the use given to the information contained in this website.

Vanguard Mexico registration number: 30119-001-(14831)-19/09/2018. The registration of Vanguard Mexico before the Comisión Nacional Bancaria y de Valores (“CNBV”) as an Asesor en Inversiones Independiente is not a certification of Vanguard Mexico’s compliance with regulation applicable to Advisory Investment Services (Servicios de Inversión Asesorados) nor a certification on the accuracy of the information provided herein. The supervision scope of the CNBV is limited to Advisory Investment Services only and not all services provided by Vanguard Mexico.

The content of this website is solely for informational purposes and does not constitute an offer or solicitation to sell or a solicitation of an offer to buy any security, nor shall any such securities be offered or sold to any person, in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities law of that jurisdiction. Reliance upon information in this website is at the sole discretion of the recipient.

Securities information provided in this website must be reviewed together with the offering information of each of the securities which may be found on Vanguard’s website:https://www.vanguardsouthamerica.com/en/products/financial-products or www.vanguard.com

Vanguard Mexico may recommend products of The Vanguard Group Inc. and its affiliates, and such affiliates and their clients may maintain positions in the securities recommended by Vanguard Mexico.

The information contained in this website derived from third-party sources is deemed reliable, however Vanguard Mexico and The Vanguard Group Inc. are not responsible and do not guarantee the completeness or accuracy of such information.

You may leave Vanguard South America’s website when you access certain links on this website. In so doing, you may be proceeding to the site of an organization that is not regulated under the Mexican regulation. Vanguard Mexico has not examined any of these websites and does not assume any responsibility for the contents of such websites nor the services, products or items offered through such websites.

The information contained in this website should not be considered as an investment recommendation, a recommendation can only be provided by Vanguard Mexico upon completion of the relevant profiling and legal processes.

This website is for educational purposes only and does not take into consideration your background and specific circumstances nor any other investment profiling circumstances that could be material for taking an investment decision. We recommend getting professional advice based on your individual circumstances before taking an investment decision.

The information contained herein does not constitute an offer or solicitation and may not be treated as such in any jurisdiction where such an offer or solicitation is against the law, or to anyone for whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so.