Han Dieperink: The end capitalism through passive investing

April 5, 2024

^{This column was originally written in Dutch. This is an English translation.}

According to Morningstar, passive investing is now bigger than the active variant. Passiveness is so great that it influences the free market.

By Han Dieperink, written in a personal capacity

Passive investing is a disruptive innovation that has made it easier and cheaper to invest. It has made even active investment solutions cheaper. Moreover, passive standardization is an ideal solution in the context of digital transformation. Advisors no longer need to know much about investing. They can simply point out the low costs and the fact that in the long term, passive investing outperforms active investing nine times out of ten.

Now the answer to the question of what market share passive investors have seems fairly simple, but it is not. Morningstar talks about funds and ETFs, but there are also institutional investors such as pension funds and insurers who invest partly passively. However, it can no longer be said that every index fund or ETF is a form of passive investing. Increasingly, these products only invest in part of the market. For example, anyone who sees a leverage inverse VIX-linked ETF as a passive solution is out of their minds. Furthermore, the definition of the (world) index does not appear to be that simple. The differences between globally investing passive asset managers are even greater than the differences between active asset managers. Moreover, almost every investor today is aware of the index, or uses it as a benchmark. Then it is inevitable that part of such a portfolio also consists of passive investments. Finally, truly passive investing would mean investing more in private markets, given the size of those markets. The 'passive investor' does not exist, but the influence of passive investing is much greater than many think.

Back when passive investing was much smaller, I argued that if everyone started investing passively, it would mean the end of capitalism. Nevertheless, capital markets seem to work well, although the index has a somewhat strange composition these days. On the one hand, there are the large tech companies that, due to their size, benefit above average from the growth of passive investing. They are so large that even active investors choose to include them because of their weight in the index. On the other hand, research by the US National Bureau of Economic Research has shown that the increasing use of index investing has made stocks in the index less sensitive to news. This is because there is no longer any incentive for the investor and the company to do anything with that news. The only thing that matters is the weight in the index. The result, among other things, is a growing percentage of zombie companies in the index. Of course, such a barbell index of big tech companies and zombies does not last forever.

Passive investing was initially a good idea, but has now become a phenomenon that threatens to destroy the growth-creating and consensus-building influence of free-market capitalism. The overleverage of passive investing is a brake on capitalism's ability to adapt, to strive for excellence, efficiency and creativity. Moreover, it leads to increasing criticism of capitalism, a capitalism that in fact no longer exists.

More columns by Han Dieperink