How Passive Investing Could Change Capitalism

Tracy Alloway (0:09)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

Joe Weisenthal (0:14)

And I'm Joe Weisenthal.

Tracy Alloway (0:16)

So Joe, we've talked before on this podcast about passive investing, right? I seem to remember that.

Joe Weisenthal (0:22)

I'm sure we must have. In fact, are there any other types of investing anymore?

If we talked about investing, I'm sure we talked about passive investing.

Tracy Alloway (0:33)

No, you're absolutely right. But I'm trying to think now, I guess that means we haven't talked about the sort of basis of passive investing, which is index construction, right? If you're gonna invest passively, you need to be investing essentially in some sort of index or benchmark.

Joe Weisenthal (0:51)

Exactly right. So you could say, oh, I'm not gonna make any choices in my investment. I'm just going to invest in the market. But even that has to have some definition. If it's the S&P 500, then whoever designs the S&P 500 is ultimately the one constructing your portfolio.

So ultimately someone is making a decision even if you think you're sort of trying to take human discretion out of the process.

Tracy Alloway (1:17)

Right. And there's really been an explosion in all types of indices recently, sort of growing in tandem with the big growth that we've seen in passive investing in general.

One thing that gets bandied around quite a lot is that there are now more indices in the world than there are individual stocks. Which, you know, stop and think about that for a moment. It's pretty amazing, although I guess, you know, you could say, given the amount of stocks available in the world, there's sort of an infinite number of combinations that you could get at that point. But it does suggest that something that was supposed to be a simple reflection of a particular market has sort of morphed into something else.

Joe Weisenthal (1:58)

Right. I think Bloomberg's Eric Belcun has had a really interesting column this week pointing out that there's only really 12 notes on an octave, but there's hundreds of millions of songs. And I think that's a pretty good analogy for the relationship between individual components and indexes.

And of course, there's essentially an infinite number of ways that you can arrange them and weight the components and weight them by size or factor or whatever. So it's not surprising that there is an incredible amount of interest and importance placed on index construction these days.

Tracy Alloway (2:39)

Right, and people's thinking about this indexation kind of issue or explosion in indices, it tends to either be of that sort of ilk where people think, oh, well, it's natural that this is happening because we have these different varieties of indexes that you can build using different types of stocks.

But there's another extreme end of this. And people who actually find it quite worrying and quite dangerous for one reason or another. And today, we are going to be speaking with someone who is firmly at that end of the discussion.

Joe Weisenthal (3:13)

I can't wait. This is a really important topic.

I joked in the beginning that is there any other type of investing besides passive? Because it really does feel like that is swallowing everything. And I think there's a real existential question about the role of what used to be called discretionary investing. And so I think it's a great, timely and timeless topic for us.

Tracy Alloway (3:41)

Yes, indeed. All right, so without further ado, our guest for this episode is Inigo Fraser-Jenkins. He is a quantitative strategist over at Bernstein. You may remember him, listeners, as the guy who wrote The Silent Road to Serfdom, Why Passive Investing is Worse Than Marxism. So I promise this is gonna be an interesting discussion.

Inigo, thank you so much for coming on.

Inigo Fraser-Jenkins (4:06)

Thank you for having me on.

Tracy Alloway (4:08)

So Inigo, I guess my first question is, you've written quite a few notes about indexing at this point in time. Your latest one is sort of unusual in the field of analyst research. It was called Fund Management Strategy.

The Man Who Created the Last Index, and it's sort of a fictional slash historical look at index creation. How did you focus on this particular topic?

Inigo Fraser-Jenkins (4:35)

Yes, so when we think about the way investment works at the moment, I think this five trillion switch from actor to passive has taken place in the last decade is one of the biggest changes that we've seen. And I think that passive has a lot further to grow.

I think that some people have interpreted some of our previous work, as the one you just mentioned earlier, as us being anti-passive in some way. I wouldn't describe myself as anti-passive because passive has done more to democratize access to capital markets than any other invention in investing in the last couple of decades.