Investing is Never Passive

  • The active vs passive investing debate should long be over, but it refuses to die. While the real debate today should center on how active and passive strategies can be combined to best meet objective needs, we continue to see clickbait headlines likening the rise of passive investing to “the misuse of antibiotics” and warning of passive ETF “bubble trouble.”
  • There’s more than meets the eye here, especially when it comes to headlines proclaiming a passive ETF investing bubble. The stories using these headlines fail to mention the fact that the devil is always in the details when it comes to assessing passive ETF fund flows.

The rise of “passive” investing

Passive funds have steadily increased their market share in the past 15 years, and charts capturing this trend—like the one below—can easily grab investors’ attention. As these flows show, there is no question that investors have gravitated toward passive funds, drawn by the allure of lower cost beta exposure. In fact, even as the market sold off in 2018, we saw index-based products take in considerably more assets in equity and fixed income strategies across mutual funds and ETFs, with index taking in $456 billion, while active lost $307.1 This boosted index-based strategies market share between index and active up to 39%.


Putting “passive” flows in context

But looking at charts without context does not capture the full story of passive fund flows. A tactical sector allocation strategy is a good example of how the term “passive investing” is a misnomer.

One of the most poignant examples took place amidst one of the most significant and memorable macro events in recent history. Flows into a Sector ETF reached more than $6 billion in November 2016, when Donald Trump won the US presidential election.2 While those $6 billion were counted as “passive” flows, the investment decision to use this fund to gain exposure to financials upon a market regime shift was clearly an active one. Investors who flocked to financials sought to generate alpha by overweighting a sector they believed would benefit from the pro-cyclical and inflationary fiscal policies promised during Trump’s campaign.

The $6 billion into this ETF was just a drop in the bucket of flows into “passive” vehicles that were driven by an active decision—sector flows across the entire ETF industry were nearly $30 billion from Election Day to the end of the year, accounting for 27% of the total post-election ETF fund flows in 2016.3

Lately, flows into sectors have been decidedly negative as investors sought to de-risk portfolios amidst an uptick in volatility witnessed late in the fourth quarter of 2018 and into early 2019 resulting from concerns of slowing corporate profits and economic sentiment juxtaposed against a tense geopolitical environment. Once again, investors were making active decisions while wielding precise index-based tools, underscoring how investing is never passive.

Passive investing: Ignore oversimplifications

It isn’t likely that flashy headlines about a so-called passive ETF bubble will disappear any time soon. But don’t buy into the oversimplifications. Investing is never passive: A decision on where to allocate capital always takes place, and that is an active one. What is lost in almost every "active vs. passive" debate is that even if the investment tool used to access an exposure is market-cap weighted, the choice to seek the exposure was not made on autopilot.

We know there are many sides to the active vs. passive debate, so stay tuned as we explore this topic in-depth, including a look at how the definition of active investing is changing, key aspects of performing due diligence on active managers and when to be active.

1Morningstar, as of 12/31/2018.
2Bloomberg Finance L.P., as of 11/30/2016.
3Bloomberg Finance L.P., as of 12/31/2016.


Active Management: The use of a human element, such as a single manager, co-managers or a team of managers, to actively manage a fund’s portfolio.
Alpha: A gauge of risk-adjusted outperformance relative to a benchmark.
Beta: Measures the volatility of a security or portfolio in relation to the market, usually as measured by the S&P 500 ® Index. A beta of 1 indicates the security will move with the market. A beta of 1.3 means the security is expected to be 30% more volatile than the market, while a beta of 0.8 means the security is expected to be 20% less volatile than the market.
Passive Management: An investment strategy that removes the active human hand from the process and replaces it with systematic, rules-based approaches to securities selection. Passive investing, notably index investing, is relatively cheap because it typically limits portfolio turnover and does not involve relatively costly research.

Important Risk Information

The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without State Street Global Advisors' express written consent. The views expressed in this material are the views of Matthew J. Bartolini, through the period ended February 2019 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Actively managed ETFs do not seek to replicate the performance of a specified index. The trademarks and service marks referenced herein are the property of their respective owners. Third party data providers make no warranties or representations of any kind relating to the accuracy, completeness or timeliness of the data and have no liability for damages of any kind relating to the use of such data.