The rise of Vanguard and ETFs in the past decade has been nothing short of astonishing, with trillions of inflows to ETF assets, and Vanguard adding more assets in the past 5 years than they did cumulatively in their first 35. Yet the question arises: why was it that made the past decade or two the rise of passive investing. Why didn’t it happen sooner? Why did it take Vanguard decades for the idea of the index fund to really gain traction?
In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, I offer an ‘alternative’ explanation for the rise of passive investing, that has little to do with the performance of passive vs active itself. Instead, I think the real catalyst that changed the flows from active to passive funds was the internet.
Because the reality is that before the internet, the average investor didn’t have the tools to know that so many actively managed mutual funds underperformed their benchmarks, and how to select which were the few funds that were actually good. Instead, most investors could only look at quarterly statements, or the Wall Street Journal’s pages of stock prices, and figure out that they had “made money” because the investment was up. But not actually whether it was up more or less than it should have been, given peer comparisons.
With the rise of the internet, though, the tools suddenly became widely available. Investors could actually do real performance benchmarking and cost comparisons for the first time. The tools were finally available to shine a bright light on relative mutual fund perfomrance, and easily identify the laggards. The technology was a transformative moment for real transparency on performance, and putting it into an easily usable format.
And now the trend only continues, likely to be accelerated by the DoL fiduciary rule, which will require all financial advisors working with retirement accounts to use those kinds of tools to do their own investment due diligence. While DoL fiduciary didn’t ban commissions, it does require a recommendation that non-commissioned prudent expert would have also suggested, which means advisors who sell commissioned products have a substantial burden to prove why they’re that good.
In fact, the ultimately conclusion of this trend may actually be a tremendous consolidation of the entire ETF and index fund world. Because the reality is that with transparent tools to make it easier than ever to find the best – which when it comes to commoditized index funds, is often nothing more than a comparison of which is the cheapest – there’s no longer a need for 100 ETFs to track an index, nor 10, nor even three. Instead, these are “winner takes all” markets – which is exactly why the ETF price wars are underway, and are likely to continue for the foreseeable future.
All caused by the transparency that good technology brings!