The Invisible Hand Inside the Index

Passive investing has become an obscured center of gravity in the macro economy. That is the charge this chapter will make, and the evidence will come from several different parts of the market that are usually examined separately.

We will begin with the obvious success of index investing itself: the long record showing that most active managers fail to beat inexpensive benchmarks after fees, the migration of trillions of dollars toward passive vehicles, and the perfectly rational decision made by millions of individual investors to stop paying someone else to guess which stocks will outperform.

Then we will change the instrument.

Instead of asking whether an index fund is a good product for the person buying it, we will ask what happens when that product becomes infrastructure. We will look at the rules that determine where new money goes. We will look at index additions and deletions, where the force becomes temporarily visible because a committee changes a list and billions of dollars must move. We will look at the growing gravitational pull of the largest constituents, not only on explicitly passive money but on active managers whose performance is judged against the same benchmarks. We will look at closing auctions, where more trading is being concentrated around benchmark-sensitive execution. And we will follow the shares into the boardroom, where the savings decisions of millions of dispersed investors have accumulated extraordinary voting authority inside a handful of asset-management firms.

The argument is not that passive investing created the Magnificent Seven, or that their valuations are fictitious, or that indexing is irrational. Several of the largest companies in the market have produced extraordinary earnings and possess formidable competitive advantages. Nor does the case require us to believe that every passive inflow pushes every large stock mechanically higher.