The Rise of Indices is Changing the Face of Investing

Written By: Angana Jacob and Sunjiv Mainie
Written by Angana Jacob and Sunjiv Mainie

Executive Summary

A confluence of factors including technology, regulation, investor skepticism of manager skill, and fee-consciousness, has favored the rise of index investing. The pace of growth and complexity of change make it difficult for investors and managers to stay informed about these critical trends. In this report, we provide an overview of the rise of indexing, as well as its impact, both realized and potential, on the asset management industry.

The first half of the paper outlines the key trends in indexing and fund management, specifically:

  1. Fees are under pressure. Changes in technology and economies of scale have helped commoditize beta;
  2. Product scope is continually broadening, with index-based investing making inroads into active management. Smart beta and the growing interest in hedge fund beta paves the way for further growth of passive index funds at the expense of active management; and
  3. Technology advances allow for mass customization and an increased focus on outcomes. The outcomes required by individual and institutional market participants are becoming critical—index funds may benefit due to their low cost and heightened transparency.

The second section of our report focuses on the changes to the asset management industry and reviews the topics that are commonly discussed in the context of a highly indexed future:

  1. Can passive investing grow too large? With large inflows into passive index funds, this is an oft-repeated question. We elaborate why this should not be a practical concern.
  2. With returns being demystified and unbundled, what are the potential implications for active management? The breakdown of returns into factors has enabled investors to be much more discerning regarding what they may be willing to pay higher fees for. This may have significant implications for fee structure and the industry as a whole.
  3. The changed definitions of beta and passive investing. Passive investing and beta have evolved considerably from their origins.

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