Economist Comes Out For Indexing!

July 09, 2007

So an economist from the investor advocacy government agency comes out for indexing.  Woo hoo.  I wish the index industry was consistently coming out with the same kind of message.

I think I might be a bit more surprised (and disturbed), Matt, if the chief economist of the SEC had come out saying investors need to run more active strategies and that hedge funds could be the savior of retail investors.  But it is nice to see it there in black and white.  I wish we could consistently say the same thing for the index industry.

Indeed, it's getting hard to say even what the index industry is these days.  The lines between active management and index investing has become ever more blurred with each increasingly resembling the other.  Indexes have gotten into ever more "asset classes", some of them so thinly sliced that the only way they can logically be used is, er, actively.  At the same time, index product fees have moved up with the volatility implicit in said slicing.

And jolly ho!  Active funds are actually seeing costs go DOWN (certainly on an asset-weighted basis) even as the largest funds look ever more like traditional, broadly diversified index funds, with the correspondent lower volatility and cost.

All that might not bother me (indeed seeing the competitive pressure of ETFs and growing indexes force down costs in the wider investment management industry has to be a good thing), but the way some of the marketing is run does grate on me.  There are two shades of this marketing that bother me: 1) Saying that you've got something with the low risk security of indexing PLUS 2% (or 4% or 10%) in FREE returns; and 2) Mix and match low cost efficient index funds (ETFs) and be your OWN active manager.  If most large active professional managers can't do it (per the SEC economist's own experience), how is Joe Bumpkin in Des Moines (sorry Des Moines) going to do it?

So the latter trend I think is the most dangerous (though I have seen some encouraging marketing from the major ETF players in this area really focused on long-term asset allocation).  But the former trend towards "enhanced indexing", "portable alpha" and the like among big ,traditionally index-focused shops is also detrimental to the end investors, and it's really been about shoring up the bottom lines of the managers.

I continue to think that the strength of the index industry is the truth and clarity of its message - that index investings is simply better for investors.  And having something that is better for smart investors will always attract more assets.  I won't say that there won't always be some kind of competitive tug and pull between fees and returns, but hopefully this continues to be offset by the drive for assets and competition among asset managers.  By and large, the indications are that it is.  There are more and better options for investors. 

Just make sure you're using those better options and not the jetsam.  

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