As the ETF universe continues to expand at a steady pace, a number of critics are voicing concerns over the risk of passive indexing. Nevertheless, ETF investors and proponents should not be so easily swayed.
There are concerns that the growth of passive indexing is distorting markets, reports John Authers for the Financial Times. Specifically, some are wary that market-cap weighted indexing, where funds buy stocks in proportion to their market value, could cause expensive stocks to become even more expensive, fueling a classic investment bubble.
However, BlackRock recently countered these claims, arguing that indexing investing supports vibrant capital markets.
“Index investing provides a number of important benefits,” according to a BlackRock research note. “First, given the diversity of indexes and the breadth of their holdings, index funds provide capital to a very large number of companies across the spectrum of size, geography, and sector. Second, index investors take a long-term perspective on the companies that they hold. In an era where longtermism is a scarcity, these funds provide stability. Third, sponsors of large index funds are actively engaged in investment stewardship. The scale of these funds allows firms to invest more resources in this area. As a result, most large index funds vote their proxies, rather than outsourcing this function to a proxy advisory firm. Finally, index funds democratize access to diversified investment portfolios”
For instance, BlackRock illustrated that correlations between different stocks and between asset classes have diminished somewhat during the years that passive investing has grown in popularity. Consequently, passive investors may still be able to find areas that zig as markets zag, potentially obviating some of the negative effects of a potential downturn.