(Karl Marx and an iPhone. A symbol of our times, depending.Apple / Wikimedia, CC)
The rise of passive investing is the money management world's biggest trend of the last generation.
Earlier this year, we highlighted data from Vanguard that showed that money parked in funds seeking to meet rather than beat a benchmark index had risen to $4 trillion in 2015 from $11 million 40 years ago.
Analysts at Bernstein led by Inigo Fraser-Jenkins, however, argue forcefully in a new note to clients that the rise of passive investing presents some seriously dangerous real-world barriers to the efficient allocation of capital in the economy.
This is bad.
Capitalism, the argument goes, is the most efficient economic system for allocating capital in an economy, as a profit motive leads to the most beneficial economic outcomes for the largest number of people in that economy.
The alternative to this, broadly speaking, is Marxism. Under this system, the allocation of capital is centrally planned. The motivation is not an accumulation of profit, but a collective sharing of some common prosperity.
And in Bernstein's view, this central planning is better than an economy in which a lot of money is passively invested.
"Active investment decisions form a crucial part of the capital allocation process in an economy and as such there is a clear and distinct social worth in their aggregate action," the analysts wrote.
"A possible alternative is a Marxist economy where the capital allocation is planned, such a system is perfectly viable but just less effective. However, a supposedly capitalist economy with no active investment — where passive management is the only capital allocation process — is, in our opinion, worse than either of these alternatives."
Bernstein added that "the commonality between both active market management and the Marxist approach is that in both cases there are a set of agents trying — at least in principle — to optimise the flows of capital in the real economy. It is just such a feature that is lacking in passive investment management."
Perhaps one of the most interesting stats put forth by Bernstein is that the number of passive investment opportunities available to investors exceeds the number of large-cap stocks in the market. In other words, there are more ways for investors to cheaply bet on a basket of stocks than there are individual stocks you could bet on.
And I think the easy way this proliferation of passive funds could be viewed as, perhaps, an outcome worse than centrally planned Marxism is that a rise in the ways to rejigger existing investment options should not exceed those options unless market participants are either lazy or ill-informed — or both.