11. The Active Versus Passive Debate

In 2018, Vanguard group passed the $5 trillion mark in assets under management, closing in on BlackRock, the largest with $6 trillion. It was also the fastest growing manager. Question: How does the largest index fund manager get this big and add $368 billion in a single year? (Flood, Chris, “Vanguard retains title as world’s fastest-growing asset manager”, Financial Times, Jan. 4, 2018) Answer: Investors’ insatiable desire for cheap, index investing.

The Active versus Passive debate has been raging since the 1970s, and lately the Passive side has been winning, and winning big, with now nearly half of all US equities in some form of index fund (Merker, Christopher, “Investing: Past, Present and Future”, CFA Enterprising Investor, April 25, 2018). A market that has done nothing but gone straight up since the global financial crisis in 2008 has helped. The argument for passive investing is admittedly compelling in the sense that the fees for active managers can automatically detract from the performance of the fund, and therefore the “alpha” or outperformance of the fund must not only exceed a given benchmark, but a benchmark net of the fee. From there they simply point to the performance track record of managers, showing that many fail to beat the market, or at least beat it consistently. From where did this argument emerge? What are the theoretical underpinnings to it? Since when did beating the market become the mantra?