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BlackRock Jumps to the Defense of Index Investing

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As the popularity of index investing has surged, so has commentary citing concern about its growth.

These concerns are often presented under attention-grabbing headlines:

In its October ViewPoint, BlackRock, which manages the iShares ETFs, considers some of the questions being raised.

The concerns have two themes, it says. Some commentators have asked whether index funds — index mutual funds and exchange-traded funds — have the potential to distort investment flows, create stock price bubbles or, conversely, aggravate a decline in market prices.

Others have focused on index investing, stock ownership and competition, and ascribed higher consumer prices, escalating executive compensation and aspects of wealth inequality to index investment products — academics call this “common ownership”: ownership by a single entity of shares of multiple companies in an industry.

According to the BlackRock paper, overall asset allocation decisions of asset owners drive investment flows into different asset classes and sectors. Index funds are merely a vehicle for asset owners’ views; the funds themselves do not drive equity market prices or individual stock prices.

Absent index funds, it says, these asset allocations decisions would be executed through an alternative means, such as active funds or individual stocks.

Despite what headlines say, active strategies dominate both stock trading and information sources used in price discovery, according to BlackRock.

Index investing comprises only some 20% of global equities, with index funds and ETFs representing 7.4% of global equities.

Even though index investing is growing more rapidly that active strategies, BlackRock believes the balance in market share between the two is self-regulating.

It says the market share of index investments has not reached the point where pricing inefficiencies have opened up, but even if it did, active managers would benefit from opportunities to profit from short-term fluctuations in individual stock price.

This could improve active performance and would likely attract asset flows back into active management, which in turn would result in a new equilibrium between the two styles.

The BlackRock paper points out several benefits of index investing:

  • Index funds provide capital to many companies across size, geography and sector
  • Index investors take a long-term view on companies they hold, providing stability
  • Large index fund sponsors actively engage in investment stewardship
  • Index funds democratize access to diversified investment portfolios

BlackRock notes that several global trends are driving adoption of index investing strategies. For one, awareness is growing of the value proposition they offer in striving to track rather than better a benchmark index.

For another, investors and regulators are increasingly focused on fees and transparency.

And brokerage and advice model changes have led investment advisors more and more often to act less as stock or fund selectors and focus more on building diversified portfolios, often delivered through index funds.

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