How Passive Can Active Be?

Index construction is getting bizarrely active.

Bloomberg’s Matt Levine has an interesting (and entertaining) post today that highlights a broader theme we’ve discussed on this website a number of times: Index funds don’t equate to passive investing.

Levine’s tale (read it for yourself right here) recounts the creation of a new “index fund”—why this is in quotes will be clear soon, I promise. The fund in question is the Pax Ellevate Global Women’s Index Fund, designed to mirror an index of stocks that promote gender equality (a noble goal, no doubt). The index it mirrors is the Pax Global Women’s Leadership Index, which was created so the fund could be created, by the company that created it. I have no issue with this at all except the label, “Index Fund,” which is a technical term and I doubt many folks think this when they think of indexing. Levine calls this active management and he’s right. This fund also isn’t alone, it’s just a really good example of an index fund that mirrors a very actively created index.

If you want a similar situation, look no further than the S&P 500 Dividend Aristocrats Index which is basically an equal-weighted version of the high dividend stocks with a history of increasing dividends in the market-cap weighted S&P 500 Index.[i] That’s a mouthful, and a whole lot of criteria to select.

So if you buy this or a similar active-index index fund and hold it passively, are you active or passive? In my view, you’re active! You can’t be a passive investor who employs an active strategy via an “index fund.”

But most index fund investors aren’t passive at all anyway. They own a self-selected menu of passive index funds rather than one—each fund is passively indexing, but selecting the combination is active. Or they actively flip in and out of these passive funds over time. Now there are passive funds that mirror an active index. It’s only a matter of time before someone sells a passive fund of passive funds—or an active fund of passive funds. Oh wait. They already are.

My guess is how active or passive your strategy is may be a matter of opinion. Some folks seem to emphasize the degree of trading activity, so buying and holding anything would be less active and more passive. But in my view, it’s among the most active—actively selecting and passively holding the same stocks for years presumes the investor has actively selected long-term superior stocks. That’s the antithesis of passive investing. Ultimately,I guess investors who seek to be as passive as possible now have to actively analyze the funds they buy to ensure they’re passively indexing a passive index.

[i] Yes, it’s a real index. It is not similar to the Disney flick The Aristocats or the very different movie The Aristocrats starring Penn and Teller and about 50 other comedians. Don’t mix those two movies up.

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