With low fees, excellent diversification, and probabilities in the investor’s favor, indexing and passive investing have been on the rise for the last 40 years. Vanguard is a leader in this field, offering investors access to the world’s stocks for less than a tenth of a percent.
A common question that repeatedly arises is “What if everybody indexes?”. While I don’t think this is an issue (since prices are set at the margin and more that 95% of trading on the exchanges is the result of active flows) this question is not without merit. To even begin answering this question, it is important to understand the current size of passive indexing. This is not as obvious as it may initially seem. FT reports that passive investing is a third of the market, another source says it’s 24%, while another estimate says it’s less than 10%. So, which is it?
In order to answer this, a ground up approach is required. The key is that most passive investing happens at the large fund houses, and these are listed in 13-D and 13-F filings at the SEC. One can also look at an aggregator like Morningstar for some of this data. To estimate this, I looked at three large stocks, and made a best effort to classify the largest institutional holders as active vs passive. I chose GE, Apple, and Microsoft in order to avoid dealing with significant float adjustments.
As an example, here is the table for GE along with my best effort classification of passive vs active nature of the institutional holder.
|Vanguard Group Inc||7.00||Yes|
|State Street Corp||3.85||Yes|
|GE Savings and Security Program||4.29||No|
|BlackRock Institutional Trust Company NA||2.64||Yes|
|Capital World Investors||1.81||No|
|Capital Research Global Investors||1.49||No|
|Northern Trust Investments N A||1.34||No|
|Fidelity Management and Research Company||1.07||Yes|
|Harris Associates L.P.||1.01||No|
|Geode Capital Management, LLC||0.99||No|
|Government Pension Fund of Norway - Global||0.7||No|
|State Street Global Advisors (Aus) Ltd||1.28||Yes|
|Trian Fund Management LP||0.82||No|
|Franklin Advisers Inc||0.79||Yes|
|T. Rowe Price Associates, Inc.||0.68||Yes|
|Managed Account Advisors LLC||0.68||No|
|Merrill Lynch & Co Inc||0.59||No|
|Wellington Management Company LLP||0.59||No|
|Morgan Stanley Smith Barney LLC||0.56||No|
|Barrow Hanley Mewhinney & Strauss LLC||0.75||No|
Adding only the passive ownership, we get the following:
However, we must not forget that there are several passive funds that aren’t on the list above. We can adjust for this by using the pareto rule. We also need to adjust for the fact that all passive focused institutions including Vanguard themselves have several active funds. In fact, Vanguard itself has around 20% of it’s AUM in active funds ($1T / $5T).
|Adjust for Tail (Pareto rule)||24.30%|
Thus, the estimate for passive indexing is ~17%. This is not a large number by any means and I suspect that it will ebb and flow with the markets itself. Passive indexing is efficient in many ways, including costs, diversification, and portfolio risk, but on it’s own, it does not remove the behavioral fragilities of the individual investor!