Episode 400: The Evolution of Index Fund Investing

In this special 400th episode, the Rational Reminder hosts reflect on 50 years of index investing and the profound impact it has had on financial markets, investor behavior, and the cost of investing. The episode features a panel moderated by Ben Felix at the New York Stock Exchange—hosted by Vanguard and S&P Dow Jones Indices—bringing together leading voices in the indexing world to explore how passive investing evolved and what it means for the future of capital markets. Ben is joined on the panel by Tim Edwards (S&P Dow Jones Indices), Jim Rowley (Vanguard), and Shelly Antoniewicz (Investment Company Institute) to discuss the mechanics of indexing, the myths surrounding passive investing, and the evidence on how index funds affect markets. They unpack questions about market concentration, price discovery, and whether indexing is changing the structure of capital markets.

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Key Points From This Episode:

(0:00:04) Introduction to the Rational Reminder podcast and the hosts from PWL Capital.

(0:00:24) Celebrating the 400th episode and reflecting on nearly eight years of podcasting.

(0:01:09) Dan Bortolotti discusses the early days of podcasting and the transition from the Couch Potato podcast.

(0:02:11) The rise of podcasts and YouTube as major sources of financial education for investors.

(0:02:49) How Rational Reminder grew after Dan ended his previous podcast and the demand for Canadian investing content.

(0:03:47) The podcast reaches a record audience with over 384,000 views and downloads in January 2026.

(0:04:19) Institutional investors—foundations, endowments, and unions—show increasing interest in PWL’s low-cost index approach.

(0:06:20) Why indexing can still be a difficult sell for institutional investment committees.

(0:08:25) Peer effects in institutional investing: committees often hesitate to adopt strategies that seem unconventional.

(0:09:11) 2026 marks 50 years since Vanguard launched the first retail index fund in 1976.

(0:10:08) Ben moderates a panel at the New York Stock Exchange on the future of index investing.

(0:11:55) Overview of the panel participants from Vanguard, S&P Dow Jones Indices, and the Investment Company Institute.

(0:13:07) Discussion of research papers presented at the event examining index investing’s market impact.

(0:14:32) Historical context: the S&P 500 is currently as concentrated as it was in the mid-1960s.

(0:15:36) The largest companies in 1965—AT&T, Kodak, GM, IBM—eventually faded from dominance.

(0:17:43) A hidden advantage of cap-weighted indexing: investors automatically own future winners.

(0:20:59) Debate about whether today’s tech-heavy market concentration differs from past cycles.

(0:23:30) The explosion of index funds and ETFs has created thousands of ways to implement passive strategies.

(0:26:42) Technical improvements in ETF implementation, including lower tracking error and better hedging.

(0:29:02) The “Vanguard Effect”: index investing has driven massive reductions in investment fees.

(0:29:38) Index funds account for about 23% of total U.S. market capitalization, not the commonly cited 50%.

(0:32:48) Evidence suggesting index funds have not increased large-cap concentration in markets.

(0:34:25) Passive funds represent only about 1–2% of daily trading activity.

(0:36:16) Dispersion in stock returns remains high, meaning opportunities for active management still exist.

(0:38:12) Panel begins: defining passive investing and why the term is more complex than it seems.

(0:42:13) Who invests in index funds? Millions of households using them primarily for retirement savings.

(0:45:22) How advisors and institutions use ETFs to build diversified long-term portfolios.

(0:46:19) The surprising role of ETFs in trading and market liquidity.

(0:48:30) The proliferation of niche ETFs raises questions about whether indexing has strayed from Bogle’s vision.

(0:49:49) Academic research offers conflicting views on indexing’s effect on market efficiency.

(0:52:27) Evidence suggests index fund growth has not increased market volatility.

(0:54:25) Dispersion data shows indexing does not eliminate opportunities for stock picking.

(0:57:15) Index funds own only about 30% of the U.S. stock market, leaving the majority in active hands.

(0:59:42) Historical perspective: high market concentration has occurred before and eventually declined.

(1:02:14) Research remains inconclusive about whether indexing harms markets.

(1:05:25) Over 20 years, 94% of actively managed U.S. equity mutual funds underperformed the S&P 500.

(1:06:20) Post-panel reflections and discussion with the Rational Reminder hosts.

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Read The Transcript:

Ben Felix: This is the Rational Reminder Podcast, a weekly reality check on sensible investing and financial decision-making from two Canadians. We're hosted by me, Benjamin Felix, Chief Investment Officer, and Cameron Passmore, Chief Executive Officer at PWL Capital.

Cameron Passmore: Can you imagine this is our 400th episode? It's so great to be here with you guys. Welcome everybody to this episode. 

400, can you imagine? Almost eight years ago, Ben, we just sat down in that room and started recording and here we are still. I mean, you guys are doing way more of the lifting now, clearly, but pretty cool to be here with you guys.

Ben Wilson: I still remember being back in the office when you guys first were talking about this idea and said, if this could be valuable for 10 or 20 clients to get more information and allow us to scale the business to get Ben out of meetings, it'll be a win. It's just amazing how far it's come since then.

Cameron Passmore: Did it overlap with your podcast, Dan?

Dan Bortolotti: Yeah, I think so. I think I was still doing the Couch Potato podcast for, I don't know, a year or two after you guys started and then I just moved away from it and then was really happy to get invited back to get behind the mic again. It's been a great experience and just such a big audience to be able to reach this time around. 

And it's great to have all of the different approaches that the four of us have had and the other co-hosts. Everybody brings something a little bit different. I think the mix has worked really well.

Cameron Passmore: And certainly your podcast was an inspiration for us. It was really well done.

Ben Felix: For sure.

Dan Bortolotti: Well, it was in really in the early days. I think I launched it in 2016 and there wasn't a whole lot of podcasting being done back then. It was a bit of a novelty.

And of course, now it's completely replaced most other forms of content creation podcasts in YouTube. And we've managed to kind of, I think, get in ahead of the curve and then just ride the wave.

Cameron Passmore: I think for so many people, this has become kind of the default source of answers, right? For whatever question comes up. We had a client meeting here this morning and I was quite impressed actually and surprised at how much on a specific retirement question this person had done with other podcasts and YouTube channels that we all know. Dang, they're doing the homework. Pretty cool.

Dan Bortolotti: There's a lot of good creators out there now. There's a lot of information that's low quality, but the production quality and the content of a lot of the material out there now is really very good. And if you are careful about curating it, you can definitely learn a lot.

Ben Felix: Never would have guessed we'd get to 400 episodes when we started Cameron. And Dan, I think your podcast was definitely an inspiration and you stopping your podcast, I think was also a pretty big tailwind for Rational Reminder to pick up because a lot of that audience, you stopped and they were like, well, what am I going to listen to now for Canadian content?

Ben Wilson: That's interesting. 

Cameron Passmore: Gosh, you remember the uproar?

Ben Felix: Yeah.

Cameron Passmore: I remember that episode, Dan. It was such a shocking end.

Dan Bortolotti: It's something I look back on. I mean, I wish I could have continued it. It was a very different podcasting world back then. 

I literally did 95% of that podcast on my own. It was only at the very end that I was able to send it off to a producer to stitch it together. But I mean, just the writing, recording, editing, all of that was all done by me. 

And nowadays, I mean, the process is a lot more streamlined, let's call it. There's a lot more people involved. We have a great team here, but it was a different time.

Ben Felix: I mentioned last year that we had had a record month for views and downloads on this podcast. That was October of 2025 that we'd had our highest month ever. And we actually blew past those numbers in January. 

We had 384,000 combined views on YouTube and downloads on the various audio platforms in the month of January. So that's pretty crazy. So we continue to appreciate everyone's support. 

We would love to see the audience continue to grow. So I think if you're enjoying the podcast, be great for you to share it with someone who you think might enjoy it. And I do also want to mention that something that we haven't really tried to do, but has been happening is that we've been hearing from institutional investors who are interested in having PWL manage their institutional portfolios. 

That's things like foundations, educational institutions, endowments, reserve funds for not-for-profits, trade unions. It's really hard to find firms like PWL in the institutional world who will support an institution, an organization with planning-focused advice. People think of financial planning as being for retail investors, but institutions need planning too. 

How much can you sustainably spend from your reserve fund or endowment? Combining that type of planning with investing in a simple low-cost portfolio of index funds, that's really hard to find in the institutional world. If you are listening and you sit on an investment committee for an institution that is currently invested in high fee actively managed funds, as many of them still are, while not getting much strategic advice, we would love the opportunity to speak to your investment committee.

Cameron Passmore: An awareness on this approach is increasing all the time. And as there's turnover in these organizations, that thinking, I think, is permeating those organizations more and more.

Ben Felix: That's one of the interesting things about institutions is that they typically have investment committees. There's a group of people who are making these decisions together and committees do turn over, but the composition of those committees really dictates how the institution ends up investing. As like the type of people that tend to listen to this podcast who believe that investing should be done a certain way. 

As more of them end up on investment committees, I think that more institutions will want to adopt this approach. Index funds are a lot more mainstream than they were, for example, Dan, when you started your blog. But if you approach somebody on the street and ask them whether index funds make sense or not, you're not going to get a whole bunch of intelligible answers, I don't think.

Dan Bortolotti: I feel like in the institutional space too, it's still a hard sell. I'm feeling like if somebody is appointed to the investment committee of an institution, they feel like indexing is just a default, quote unquote, do nothing option. We still hear those objections from time to time that if we're going to put the time and effort into putting together a committee, then we should be able to assemble the best managers. 

I have actually done a couple of institutional presentations, and that has been my limited experience. Somebody would bring me in because they understood the value of indexing. They say, I need you to make this pitch to the investment committee. 

Most other people just had not done the research or had different inclinations. Someone else would come in with a snappier presentation and making all sorts of promises that they probably would not be able to fulfill, but that's who gets the mandate. It's much easier to make that pitch to retail investors. 

I think institutions seem to be a little bit tougher of an audience. Hopefully that's changing. Lots of big institutions use indexing mandates. 

It's not unheard of, and there's plenty of research out there that shows most institutions who hire active managers tend to underperform. They fire them at the wrong time, et cetera. Same old story.

Ben Wilson: The interesting thing we've noticed is that they're all testing their returns to a benchmark, which is an index. When we come turn around and say, we'll just buy the index for you and provide this other value-added planning advice at a very competitive cost relative to what they're offered in the institutional space, it becomes more interesting. This is just a different offering than what is out there and a different way of looking at it.

They test the tracking error. If there's a lot of tracking error, it leads to more manager turnover. If you can avoid some of that turnover, it becomes a new opportunity for the investment committee.

Ben Felix: I think a lot of it's peer effects, too. Dan, to your point about it being a tougher sell, institutions care a lot about what other institutions are doing. Most institutions are not primarily using index funds. 

When they look around to their peers and think, is us using index funds going to be weird? Because no investment committee wants to be weird because if you do a weird thing and it blows up or it doesn't work out, you got the egg on your face or whatever expression you want to use. If you do what everybody else is doing, there's a lot less risk. 

Anyway, all that to say, love to hear from people on investment committees so that we can talk to your committee about why index investing does make sense for institutions. That was a very long introduction. Are you guys ready to go to the episode?

Dan Bortolotti: Ready to go.

Ben Felix: I call this episode Reflecting on 50 years of Index Investing.

Cameron Passmore: Touchy.

Ben Felix: Well, this year, 2026, this marks 50 years since the first retail index fund was launched by Vanguard.

There were some index strategies that existed before that, but the first retail fund was launched by Vanguard in 1976. Now, index investing has obviously grown a ton in terms of assets under management and the breadth of index products available. It's not just market cap weighted index funds anymore. 

The other thing that's interesting is that it's possible that index funds are having effects on how financial markets themselves function. In early February, well, I was invited earlier than that, but in early February, I moderated a panel at an event put on by Vanguard and S&P at the New York Stock Exchange. It was like an industry event designed to reflect on the past, current state and the future of index investing. It was pretty cool.

Cameron Passmore: You're right in the stock exchange building.

Ben Felix: Right in the stock exchange building. Yeah. It was cool. A company was having an IPO, Bob's Furniture or something like that. There's all this stuff set up in front of the exchange for that. We were just in an event room in the building.

The event was titled The Future of Capital Markets Unlocking Potential Ahead. The panel that I moderated was Benefits Beyond Beta: Charting the Evolution of Indexing. My panelists were Tim Edwards, who's the Managing Director and Global Head of Index Investment Strategy at S&P Dow Jones Indices. 

Jim Rowley, the Global Head of Investment Implementation Research at Vanguard. Shelly Antoniewicz, the Chief Economist at ICI, which is the leading trade association representing the asset management industry and the individual investors they serve. ICI does a lot of really interesting research on the fund industry. 

We will actually have Shelly on the podcast later this year and we will have Tim on the podcast later this year as well. Jim was a guest back in episode 368. The panel was cool. 

I didn't know if I would be able to do this or not, but I asked at the event and Vanguard generously allowed us to republish the footage from the panel. I had to sign all these speaker releases about how Vanguard and S&P would own the content afterwards, but they were gracious enough to let us use the footage from the panel as a podcast episode. We're going to play that panel in a bit, but to give some background for the panel discussion, I wanted to go through some of the thought leadership pieces that were produced for the event. 

Vanguard and S&P both produced research that was given to all attendees and we will link to that in the show notes. They did publish it online.

Dan Bortolotti: Can you talk about who the attendees were, Ben?

Ben Felix: I talked to a bunch of people. There were a bunch of people from Vanguard and from S&P, but there were a bunch of media people, a bunch of industry people. My understanding is that they were very selective. They said that they hand-picked all of the attendees. That's all I know.

Cameron Passmore: Interesting.

Ben Felix: There were multiple people there who listen to this podcast because they came up to me to talk to me about it. That was neat.

Dan Bortolotti: Did you get to visit the floor of the exchange?

Ben Felix: No. Maybe you could have, but apparently it's a bit of a ghost town these days. I need to mention that the panel's view is generally that index funds have been a great innovation, which we all agree with, and that index funds are not causing a lot of the issues that are often attributed to them. 

That was a focus of the panel. I generally lean in the same direction as the other panelists that were on there and have continued to be a proponent of index investing. I just want to acknowledge that this panel is like asking a panel of butchers whether beef causes cancer. 

I'd include myself and the butchers in that analogy to be clear. We've got Vanguard, S&P, and ICI. None of them are going to tell you that index funds are bad.

Cameron Passmore: I appreciate the butcher reference.

Ben Felix: Cameron, former butcher.

Cameron Passmore: Nice touch.

Ben Felix: If people want to hear different views on how index funds may be affecting markets, we've done a bunch of episodes with researchers and practitioners on various related topics and perspectives on those potential effects. I do want to note before we get into some of these papers that the panel had no slides, so there's nothing to see while we're talking there other than the people, I guess. 

During this first part of the discussion, we will show lots of charts. The papers had a whole bunch of charts in them. If you're on YouTube, you'll be able to see them. 

If you're on Spotify, you can toggle to see the video and look at the charts. You can read the accompanying PDFs, which we'll link, but it might be hard to, I guess, track exactly which charts we're speaking to. If you're on audio, it should still be fine just listening, but just know that there are accompanying charts that you may want to look at.

Ben Wilson: Do watch the panel. It's a rare occurrence of Ben Felix wearing a blazer.

Ben Felix: Wearing a blazer. I was the only person in the New York Stock Exchange that day that was not wearing leather shoes. I decided that I would bring all black running shoes because I thought, there's no way.

Ben Wilson: The dressy running shoes. You're hip.

Ben Felix: I didn't think I'd be the only person not wearing leather dress shoes. I don't know.

Ben Wilson: Who would think at the New York Stock Exchange? Knock us over with a feather.

Dan Bortolotti: They just didn't have your size 19. Is that what it was?

Ben Felix: People probably just assume that. I figured that no one judged me too hard because they must have just assumed I can't find shoes. It's partially true. 

It's not easy to find shoes, but I can find them. I don't own any leather shoes currently. I got rid of all of them and I've had no need to buy any. 

The first paper is from Tim Edwards titled In the Shadow of Giant: Navigating the Long-Term Dynamics of Performance and Concentration in US Equities. This is, of course, one of the issues people are bringing up a lot right now is the levels of concentration, particularly in the US stock market, which is kind of funny because many other stock markets are and have been more concentrated than the US market. Nobody seems to mind. 

The US market is currently concentrated, more concentrated than it has been at other times in history. Tim's paper looks at US market concentration in a historical context and shows that the S&P 500 is about as concentrated at the time of the paper. It's about June 2025 data as it had ever been going back to 1965. 

Then Tim asks what happened the last time 10 companies held a similar index weight. It's kind of neat, just a simple historical analysis. In June 1965, when index concentration was similarly high as it is today, the top companies in the S&P 500 were AT&T, DuPont, Kodak, General Motors, Texaco, Chevron, ExxonMobil, Sears, IBM and GE. 

Obviously not the biggest companies today. What's interesting, what they show in the paper is that from 1965 to June 2025, those huge stocks declined to be a tiny part of the index. One of them merged with another company and then a bunch of them left the index entirely. 

It would seem safe to assume based on that, based on all those previously huge companies that made up around 40% of the index declining to being tiny components or leaving the index entirely, it would seem safe to assume that the index as a whole performed poorly over that period. We all know, this is the S&P 500, we all know that's not what happened. This research kind of shows that as we've shown in the past, we've done similar analysis in the past, there's very little relationship, if any, between index concentration and future returns. 

One of the reasons is what we might call creative destruction. Large companies today become smaller in the future as the world changes. Economies change, business models change, new companies become successful and large. 

We've seen that with our current tech and AI companies. They're all the ones that became massive over the previously large companies. The paper concludes that at least statistically, today's cohort of the very largest companies is unlikely to represent the very best performing stocks in the future. 

We've spoken about that in the past too. Dimensional had done some research on that as well. If they do flounder, their weights in the benchmark will naturally decline. 

Future leaders may already be included among the relative minnows in the index, in which case a capitalization weighted approach ensures both initial participation in their gains and a future weight that grows in proportion to their relative outperformance. That's the first paper. Thoughts?

Dan Bortolotti: Sort of a hidden benefit of cap weighting that I think a lot of people don't appreciate or don't talk about is the idea that no, you cannot pick the next Google, the next Amazon, but you don't need to if you hold the total market index because you will already own it and it will increase its share of the index gradually over time. If you could read the future, you would overweight that stock. I mean, we get it. 

You probably only own a tiny, tiny portion of it at the beginning, but the point is by having exposure to everything all of the time, you are exposing yourself to all of the future winners as well as all of the future losers. If you believe that markets in aggregate go up over time, it's a perfectly reasonable strategy to hold everything. It's very selective to think that you can get in and out at the right time when building an index or picking individual stocks in your portfolio. It's the same thing.

Cameron Passmore: It goes back to the Hank Bessembinder research and different people have different takeaways. Some people take away from that research. I can avoid the duds and pick the good ones. Other people say that doesn't make any sense whatsoever.

Ben Felix: Yeah, exactly. That's where I think Hank would tell people to review the literature on overconfidence if they think that they can be the ones to pick those mega winners, but you're right.

Ben Wilson: Then on the flip side, people don't want to be over-concentrated to the current winners because they're afraid they're going to go down, but you also can't predict that side, so it's better to just own the market as a whole. Yes, you're going to ride those ones down if they don't do well, but you'll also ride up the ones that replace them in the future. You can't know with certainty what's going to do well, so it's better to just own everything all at once.

Cameron Passmore: When you think about those winners, the experience of Amazon, the classic Amazon, how many times it fell some ungodly amount, would you really have stuck through those 90% drops? Just take your current portfolio and knock off 90%.

Ben Wilson: Yeah, it's a good point.  

Cameron Passmore: Really? That's not causing a little bit of stress?

Dan Bortolotti: At some point, you would just conclude that, hey, I thought this was going to be the next big winner, but clearly not. It's easy to look back and say, oh, it's Amazon. If I just held on, it would have become Amazon, but you didn't know where it was going to go at the time. 

You would not have had that kind of confidence, but the other interesting thing here is that if you go back to that other period of high concentration in 1965, though, the sectors that those big companies were in were a little bit more varied than they are today. They're basically all tech companies today, whereas here you've got, what, three oil companies, but you've got a retailer, a photography company, Kodak, chemical producer, telecoms, GE. You have at least three or four different significant sectors there, so it was probably a little bit more diversified. 

There was no reason necessarily to believe that all of those companies could be hit by the same kind of shock, whereas tech companies are probably a little bit more vulnerable to moving in lockstep than those were back in 65.

Ben Felix: They're pretty diverse, though. You look at the big companies today, they are all technology companies, but I mean, what isn't, to some extent, a technology company today? Everyone is using technology, but the actual fundamental revenue sources from today's large companies, they're not all the same.

Dan Bortolotti: Yeah. Amazon is not Nvidia. Yes, they're tech companies, but it's naive, I guess, to suggest that they're highly correlated.

Ben Felix: They might be. They might still be, but if some fundamental shock affected Amazon's business, that same fundamental shock won't necessarily affect, I don't know, Google's business or Nvidia's business.

Ben Wilson: Yeah, and if you take that down another level, each business is fairly highly diversified in terms of revenue sources, just in that individual company as well.

Ben Felix: Agreed. That was Tim's paper. Then Jim Rowley also had a paper. 

His paper was shared the same title as our panel, so Benefits Beyond Beta: Charting the Evolution of Index Fund Investing. His paper shows that while indices like the S&P 500 are still prevalent and important today, there are many, many more indices tracking all kinds of different parts of the market. I think he makes this point on the panel too. 

Index funds are spoken about as this monolith, as this one big thing that owns a lot of the market, but in reality, they're really diverse strategies that track lots of different things, lots of different parts of the market. They're also used in different ways. Not everybody just buys and holds index funds. 

They're often used in an active way or as part of an active strategy. Another thing that the paper touches on that we've talked about, I don't know when, but we have talked about on the podcast at some point in the past, is that indices with similar names can be very different depending on the index provider. If you think about stuff like how does the index you're looking at define company size? 

How does it define growth versus value? How frequently does the index rebalance? Those can all result in pretty material differences between two funds that are labeled small cap or value or small cap value. 

They're just making the point in the paper, again, that index funds are pretty dispersed in terms of what they actually own and what they do, even for funds with a shared name. That's that paper. Then there's one more paper that was not in the conference package, but it's another paper from Jim Rowley that he draws on pretty extensively. 

I'll talk about that one last. Any comments though on the diverse set of index funds that exist?

Dan Bortolotti: I thought this paper was really interesting too, because I think it's such a great point to appreciate how index funds and indexing strategies from a practical point of view has changed so much, and that 20 years ago, if you were one of the rare people who advocated index investing, your decision about how to implement that decision was pretty easy. At least in Canada, you basically had one big index provider and a small number of ETFs to choose from. I'm exaggerating a bit, but not that much. 

Whereas today, once you've made the decision to build a passive portfolio, yes, there are easy solutions, right? The one fund solutions are available, but there's lots of those too. They're all built a little bit differently, and there's thousands of other ETFs and index funds to choose from. 

If it's not actually thousands, it feels like it. You really do need to have some expertise in how to evaluate how an index is constructed, what's included, what's not. If I want to buy an ETF that holds US stocks, say for example, am I going total market, large cap, mid cap, NASDAQ? 

There's all sorts of different ways to access those asset classes, and there's definitely better ways than others. I think it's just a little bit harder now to do it without guidance.

Cameron Passmore: But the information is so much better. Back in the day, the information, there was nothing.

Ben Felix: I don't know, man.

Cameron Passmore: Do you disagree?

Ben Felix: There is good information, but to say the information is better, there is so much crap out there, Cameron.

Cameron Passmore: I agree with that. There's more access to good information. Back in the day, there was scant access to information.

Ben Felix: Sure.

Cameron Passmore: Even to understand how creation and redemption would happen was like a mind bending thought experiment at the time to understand how do you do this ETF thing? It wasn't available. 

This is back in 96, 97 as it was all starting in Canada. I agree, your ETF slop and that whole commentary, 100%. There's so much noise today. My experience with AI is that it's not making things better.

 Ben Felix: Well, it's slop. It's AI slop and there's ETF slop and you add it all together and it's just, there's a lot of slop. Not so easy to navigate.

Dan Bortolotti: On the positive side though, I would add though, of the good index funds that have always been available by the reputable providers, the management of those funds has become a lot better too. I think if you go back 20 years again, you'd probably see higher tracking errors. You'd see things like representative sampling where you only purchased a subsection of the index because it wasn't practical to replicate it by buying all of the stocks. 

Currency hedging is another thing that has improved so much over the years. If that's something you want to lay over your index fund, it used to be really ham-fisted and it's much better now. Just on the technical side, the funds themselves are better and managed better. 

But again, it's just a little hard to sift through the chaff to find the good ones.

Ben Felix: That's a good point. Even on the slop comment, I do and I've said this before, I think it is absolutely incredible what we can put into an ETF. That's cool. 

There's cool stuff happening. It's probably mostly not good for investors, but it's still, from an implementation perspective, it's like, wow, that's really impressive. This last paper from Jim, which again, he alludes to some of the data in this paper during the panel discussion. 

It's called Setting the Record Straight: The Truths About Index Fund Investing. Again, we will link this in the show notes if you want to read it. It's on Vanguard's website. 

This one, this paper notes that increased adoption of index fund investing has heightened emphasis on the binary labels of passive and active as if all index funds can be described as a monolithic homogeneous strategy. That this has led, that perception has led to many faulty assertions about index fund investing. What the paper does is goes through assertions tied to the growth of index fund investing and offers evidence that refutes a lot of the key misperceptions. 

It does start off with five key benefits of index investing, which listeners probably don't need to hear, but maybe it's always good to hear. Index funds give you diversification, low costs, consistent relative return predictability. That means you know you're going to get the index return, the market return. 

You're not going to get the market return plus or minus an active return. Consistent relative return predictability. That's another big thing, on a bit of a tangent, tying it back to the introduction discussion on institutions. 

Institutions really struggle, you mentioned this Ben, with tracking error. You benchmark against an index because that's what everybody does and it makes sense to do that. Any tracking error relative to that is really, really hard for institutions to deal with because it's like, how long is this going to go on? 

Should we expect it to turn around? Usually it doesn't. Potential for tax efficiency is another benefit of index funds and simplicity and transparency. 

You kind of know what you're going to get. They also mentioned, this is something often referred to as the Vanguard Effect. They mentioned in the paper and they show data supporting it that index funds have driven down the cost of investing in both active and passive funds. 

It's like Vanguard shows up to a market. It happened in Canada. Vanguard shows up to a market and they offer super low cost funds. Everyone else has no choice. They have to lower their fees to compete.

Dan Bortolotti: We were talking about it before we started recording to what the number is there, that Vanguard had estimated that they had saved investors over $500 billion in fees since 2000 just from the advent of, and the popularity of indexing. That is a just mind blowing number that has affected. And as you pointed out, this doesn't just mean people who chose indexing saved that much. 

It means all investors have benefited from it, even the active ones, because fees on active funds have come down as well. Thank you, John Bogle.

Ben Felix: It's the Vanguard Effect. Another point that this paper makes is that index fund ownership is not as high as people often think. 

This can be contested, but we hear about 50% of the market is owned by index funds. That's 50% of the fund market. Index fund assets make up, the Vanguard paper shows about 23% of the total US market cap. 

In Canada, it's around 12%. That's year end of 2024 data. Now I say that can be contested because actual indexed strategy ownership may be higher. 

Not all index investors are index funds. If we just look at, okay, where are the index funds? Let's see how much of the market they own. 

There are lots of institutions, other types of investors that are not using ETFs or mutual funds that are following an index, or very closely following an index. Marco Salmon does have a paper on this, which is actually now published in the Journal of Financial Economics, which is pretty cool. We had him on to talk about that paper a while ago, episode 322, before it was published in a journal and now it's in a top journal. 

Kind of neat. Anyway, he used 2021 data and he showed that index funds at the time owned about 16% of the US market. That number has gone up to 23% based on Vanguard's data. 

What Marco found is that the overall passive ownership share was around 33.5%. He did that based on trading data. It was like, what proportion of investors trade like index funds, basically? You can hear him describe his whole methodology and how he got there in episode 322. 

All that to say that 23% is Vanguard's number based on index funds. The actual proportion of index investors, including non-funds, is probably quite a bit higher than that. I think the point still stands. 

It's not as high as people believe when they hear 50%. The next point in Jim's paper is that while index funds have grown and increased their ownership of the market, we already mentioned this, they are a diverse set of strategies. It's not one index fund that people buy and hold. 

It's a whole bunch of different things. Then the final section of the paper goes through the myths that they want to debunk. The first one, and this is one that Mike Green is going to love to hear. 

Hi, Mike. They say that market cap weighted index funds have not made the largest stocks larger. They explained that a market cap weighted index fund invests in each stock proportional to the stock's market cap weighting. 

This does not make any stock larger than another and thus does not reinforce concentration. Now, I would note that that logic does not account for differences in the price elasticity of small versus large stocks. We did learn about that from Valentin Haddad in episode 314. 

I would love Val to collaborate with Vanguard on understanding what's going on there. Val does show that the price elasticity of larger stocks tends to be lower. They're less elastic, which means their price response to a proportional trade of the same size should be stronger than a smaller stock. Just felt like I had to mention that.

Dan Bortolotti: We did too, but go ahead.

Ben Felix: Okay. 

One point from this Vanguard paper that I thought was really interesting is that the US equity index fund's highest proportional ownership share is in mid-cap stocks, not large caps. That's something that probably surprises a lot of people.

Dan Bortolotti: That's because probably individual investors or institutions are more likely to hold positions in individual stocks if they're mega caps. Is that the idea?

Ben Felix: I think that's it. They mentioned in the paper that on average, index investors tilt away from larger stocks. 

I wouldn't have guessed that if I had to guess. They're trying to make the point that if we're worried about index funds owning a large portion of a certain type of stock and having an effect on it, maybe we should worry about mid-caps more than large caps. No one seems to be talking about mid-caps. 

They conclude on this point that given the diversity of equity index fund offerings and investors using passive for active purposes, it should not be a surprise that index funds ownership of stocks is not market cap proportional. Index funds, they finish this with a fine point on it. They say index funds have not made the largest stocks larger. 

Not mincing words there. Then they go on to the growth of index investing having inhibited price discovery. They show there that index fund trading volume constitutes just over 1% of total trading activity, while active fund trading volume is higher at 2% of total volume. 

Even still, mutual funds and ETFs are a small part of overall market activity. It's mostly broker dealers, market makers and other investors that are constituting the lion's share of trading on a typical trading day.

Dan Bortolotti: Were you surprised that the numbers were that low? Because I was definitely that only 1% to 2% was from passive or active funds. I would have thought it would be significantly higher.

Ben Felix: With the amount of trading that market makers do, I wasn't super surprised, but I also had my mind on this calibrated to an older Vanguard paper where they showed something similar. For sure, the first time you see that number is a surprising statistic. No doubt.

They conclude on this point that while index funds are an important source of ownership, they own a lot of the market. They claim that them becoming the primary driver of market dynamics is demonstrably false. Similar to the price elasticity point, I think that the volume of index fund trading is not typically what gets cited as an issue by critics of index funds. 

It's really their price insensitivity when they do trade, which may lead to less elastic stock prices. If prices are becoming less elastic, one thing we might expect to see is increasing market volatility. The Vanguard paper does touch on this. 

They chart the relationship between the percentage of the market owned by index funds and market volatility. They show that while index funds have consistently trended upward, volatility has not commensurately done so. Lots of interesting data. 

One other interesting point made in the paper is that the dispersion in stock returns has remained relatively unchanged as index funds have grown in importance. They measure dispersion as the fraction of stocks in the Russell 3000 index that have either outperformed or underperformed the index by at least 10 percentage points in a given calendar year. The chart they have for this one shows that index fund assets have consistently trended upward, but dispersion has really not changed much over time. 

It fluctuates pretty much randomly around 70%.

Dan Bortolotti: Does that mean it's a stock picker's market this time?

Ben Felix: That section of the paper is saying, it is addressing whether there are still opportunities for active managers to outperform. That's the whole premise of that point is that opportunities for active to outperform have remained the same over time. They don't throw down on active managers there, even though they could have, but they don't throw down and say that their performance continues to be terrible relative to the index, but that's true too. 

I didn't update it. That's probably a couple of years ago now, but I went back through all the old SPIVA reports going back to the very first ones. I charted it myself over time as the proportion of whatever, five and 10 year outperformance changed over time. 

If you go back to, I think you can find maybe 2006 or 2008 or something with old SPIVA reports, and it's been flat. The proportion of active funds outperforming the index has not changed much over time. I think that speaks to their point that opportunities for active outperformance, which they're measuring as dispersion, have been pretty stable despite the growth of index funds. That's our little preamble there.

Cameron Passmore: We're just getting started, guys.

Ben Felix: Unless you guys have any other comments, we'll go ahead to the panel discussion that we mentioned earlier. 

Then stick around though, we will still do the after show after the panel. We're going to start our first panel here, Benefits Beyond Beta: Charting the Evolution of Indexing. What we're going to do is explore 50 years of index investing from wealth creation and innovation to the forces shaping the next era. 

We're going to talk about how index funds may or may not be affecting financial markets. It should be a really, really great discussion. I'm Ben Felix, your moderator. 

Please welcome our panelists, Tim Edward from S&P Dow Jones Indices, Jim Rowley from Vanguard, and Shelly Antoniewicz, Chief Economist at ICI. All right, Jim, I'd like to start with you. What is passive investing?

Jim Rowley: Great. We're going to start off the day with the most loaded question for a term I'm not really sure I like very much because I don't think there's a very good definition of it. I can give three examples or three reasons why I don't think it's a great term or there's a unified definition.

Number one is that this phrase word passive doesn't really make a distinction between fund implementation and asset allocation. A good example might be our esteemed economist right here, might decide she favors small cap value over the rest of the market. And she implements her portfolio with a small cap value index fund. 

Now, the way the headlines might say, wow, Shelly's a passive investor. Yeah, but against the total U.S. equity market, Shelly's absolutely an active investor. I think the second reason I'm not a big fan of the word passive is I've had the privilege of hearing Tim present over and over. 

Passive doesn't really make a good distinction with respect to weighting and selection criteria. And I would personally love to see Tim argue against himself about rules based indexing. Let's call it the S&P equal weighted 500. 

Is that passive or is it not passive? And I'm sure Tim could make great arguments on both sides why it is or why it isn't. And for me, the third reason it was brought up on the panel before is the concept of custom indexing or direct indexing. 

If we want to call it that. And Ben in his day job as a Chief Investment Officer could offer one of his clients an optimized S&P 500 index with a focus on tax lost harvesting and or ESG preferences. And I don't know where the dividing line is. 

What part of that is being passive? And then when all of a sudden is it just a flat out active strategy? So I sum that all up and I use those three examples to say I don't know what the definition of passive is.

Ben Felix: It gets referred to as this sort of monolithic blob of passive assets, but it's really not that.

Jim Rowley: No, I think you've heard the phrases before that we see a lot of investors using passive for the purposes of active.

Ben Felix: Tim, how does the relationship between index providers and fund companies work?

Tim Edward: There's a very simple way that index providers and fund companies interact. I hope everyone in this room knows. And then there's a subtle and dare I say it slightly more magical process that happens around that. 

The simple and obvious way, one of the reasons that we're all here today is because almost 50 years ago, soon to be 50 years ago, Vanguard and S&P partnered. Vanguard would create an investment product that rather than seeking to beat the market, sought to offer the market returns. And they did so by agreeing a license with an index provider, which allowed them to use our IP, our stocks and weights, but also to use our brand and our index name in their messaging and to use a value proposition like we are going to track not just an index, but this index. 

So I think most people know, but that's the formal way in which index providers and fund companies partner in order to offer solutions. The more interesting thing or the magic happens, and then what next? If you look at the bond markets or bond indices, the fund managers actually need to do a lot of work in order to replicate those index returns. 

And they have to often use sampling methodologies, there's a degree of trading involved. The interaction between the fund managers, the fund investors and the index providers through consultations helps us to evolve our index methodologies so that they are still representative of what the market is doing and what the market is needed. And the broader community, everyone in this room, when you start using those indices as reference points, when you start using the products that are tied to those indices, that's where the real magic happens. 

And provide your feedback to the index providers and the fund companies on how these need to evolve to reflect the market's changes. That's how indices start becoming benchmarks. That is a process that happens with high degree of community engagement.

Ben Felix: So there's a feedback loop between the index provider and the fund company. They're not operating in isolation. Makes sense. Shelly, who is investing in index funds?

Shelly Antoniewicz: Short answer, it is a lot of Main Street Americans that are investing in index funds. ICI does a bunch of investor surveys and according to our data, 37 million U.S. households, so that's half of all U.S. households, own a stock index mutual fund. And then if you think about ETFs, we've got 19 million ETF investors that are holding a stock index ETF. 

You just can't add those two numbers together because there's actually a lot of overlap between that. You know, if you think about ETF investors, about 86 percent of ETF investors who have an index fund also hold an index mutual fund. It's really sort of a subset that could have become index investors. 

These people are middle America. If you think about household income in both groups, mutual funds, ETFs, median household income for an index fund investor is $150,000. And that's household income. 

So you've got to think about like two earners. So we're talking about regular people that are saving through index funds. On the mutual fund side, the owners kind of index fund owners skew a bit older. 

The median age is 55. On the ETF side, it skews a bit younger. They're 51 years median age. 

That's because index is really very popular with younger investors. So over 20 percent of ETF investors are under 35 years old.

Ben Felix: Makes sense. The market penetration of index funds in the United States has been much greater than where I'm from. I'm from Canada, and we're still investing in a lot of active funds.

Shelly Antoniewicz: Yeah, well, they realize the benefits. They see the benefits of the low cost, the diversification, the broad market exposure.

Jim Rowley: I think what's great and should be highlighted with what Shelly talked about is, and I can't remember the exact number, but let's call it two and a half to three million dollars, I think is the number that any individual would need to save for themselves to go out and buy all the underlying securities in the S&P 500 index, fully replicate, market cap proportional, holding at least one whole share of every company.

Ben Felix: Wow.

Shelly Antoniewicz: What's interesting is how they're being used. If we look at just the stock index fund investors, over 80 percent of them, their primary financial goal is to save for retirement. So these people are getting exposure to index funds through their 401k.

And then when they either leave the job or retire, they're rolling that out into an IRA. And we find on that side that a lot of ETF investors have IRA accounts. Over 80 percent of ETF investors have IRA accounts and are really using ETFs in those IRA accounts.

Ben Felix: Jim, you alluded to this. How actively are investors trading index funds?

Jim Rowley: In terms of trading index funds themselves, I kind of go back to Shelly's point about who's investing in them. And some of my earliest exposure, if you will, to ETFs at Vanguard is working with our financial advisor services unit. And I remember when I started there, this is 2005, 2006.

For some reason, there was always this conventional wisdom that only institutions use ETFs. And I start working with this business unit to find out our third party financial advisor clients are absolutely using ETFs to build diversified portfolios in a strategic manner, I might add. Meaning even at that type of investment professional, they're not using ETFs because they like to trade them. 

They can for liquidity purposes if they want. But the idea of who's trading ETFs, at least when we think about our experience with third party financial advisors, they're not really used for trading. They're used for building long-term, low-cost, diversified portfolios.

Tim Edward: One of the interesting features about the ETF market in particular is that while there are many participants in that market who are constructing long-term, often retail or wealth portfolios, seeking long-term growth, it is important to observe that there are many active decisions being made in constructing those portfolios. But additionally, there are other communities using index funds. One of the curious facts, when you think about what is passive investing, what is index investing, not every day. 

On some days, it's Tesla. But on many days, the most traded security in the world is an index fund. It's an ETF tracking the S&P 500. 

There is an evolution that is happening in the equity and in the bond markets, whereby 40, 50 years ago, the job of an active investor was to pick individual stocks and individual bonds. And the toolkit has now expanded, where you have an intermediate role. You can use sectors, whole markets, countries, factors, et cetera, et cetera. 

And if you like, this high-frequency community is heavily involved in policing the prices, not just of individual stocks, but also market segments and whole markets. And in the interplay, the network effects between the active police, the higher-frequency community, and the investors who benefit from that level of scrutiny and price discovery is one of the more fascinating features. There are many different kinds of investors in index products. 

And some of them have a very active, very trading mentality. But that's not a bad thing, that the two communities can really benefit from each other's participation.

Ben Felix: Shelly, does that come out in the surveys that you do at all, how retail investors are using index funds?

Shelly Antoniewicz: Yes, because we ask them, what are your primary reasons for investing in funds? And given such strong penetration of index funds in our surveys, that their primary reason is retirement, also saving for children's education, emergencies. So really, truly, index funds are helping these people save to meet their financial goals.

Ben Felix: Jim, one of the things we've seen over the last probably 10 years, but in recent history, it's gotten pretty extreme, is the innovation, if we can call it that, of indices and ETFs tracking them. There's an index for everything and an ETF for everything. Do you think index funds have strayed from John Bogle's original "just buy the haystack vision?"

Jim Rowley: Because of the growth and the innovation of the types of different products, I view it as the haystack's still there. And what I mean by that is, if we're viewing funds in individuality, I don't think that's the right way to think about it. I think this idea of buying the haystack, when you think about the different products, we can still build portfolios. 

We can still own the haystack. Maybe we all have different shapes because we might have different risk preferences. We might have different parts of the market that we think are a little better positioned than others. 

But I think the right way to think about it is the enormous amount of choice with individual products is we all still collectively have a haystack. Haystacks just might be different shape versus one another.

Ben Felix: Makes sense. Bob mentioned the haters of indexing. I want to talk a little bit about that, about how index funds may or may not be affecting financial markets in different ways. 

Shelly, can you talk about what the current evidence says about how index funds are affecting financial markets?

Shelly Antoniewicz: When you look across the academic literature that's out there, there isn't a single unified conclusion about how index or index funds or index investing affects the financial markets. The findings are diverse. And in fact, you can even find published academic papers whose conclusions are in direct opposition to each other. 

For instance, there's a recent paper that's been put out by Valentin Haddad and some of his co-authors. And it's published in the American Economic Review, very well-established peer-reviewed journal. And they argue that the growing amount of index investing out there has made the demand for individual stocks less elastic. 

Basically, what that means is that their market responds less to information or price changes for these individual stocks. At the same time, in this same paper, the researchers also find that active investors still play a central role in price discovery. And the market has not become meaningfully less competitive. 

In that sense, even within one paper, there's two opposing findings on this. There's other studies. There is another paper out there that looks at the megafirms. 

That indexing creates this concentration, and I think Bob mentioned this as well, and creates these megafirms. On the other side of that, there is another paper out there that is very highly cited. It's a paper by David Autor and his co-authors, and that's published in the Quarterly Economics Journal. 

Again, another highly rated journal. And they look at these megafirms, or what they call superstar firms, and they find that the drivers for these firms having such high market caps is technological change, international growth, capital flows. It's all of these other things.

You know what's not on that list? Index funds. There's a big discrepancy, diversity of views, even within the academic literature, on what the impact of index investing is.

Ben Felix: For every PhD, there's an equal and opposite PhD, I guess.

Shelly Antoniewicz: Well, economists are on the one hand, on the other hand.

Jim Rowley: Vanguard, my colleagues and I, I can think of two pieces of research we're very fond of. If you're a superhero fan, I think the first article is, with Greater Uncertainty Comes Greater Volatility. Simply put, we looked at the link between the growth in index fund assets and market volatility. 

What we found is there's no relationship between the growth in index fund assets and market volatility, but rather we find that one of the causes of market volatility is economic uncertainty, which I don't think is a very shocking result. I think we all could have guessed that. There's another area of research that maybe has been a personal favorite of mine, and it's the concept of dispersion around security returns. 

I just had this great idea. I should have made this a guessing jar to everybody walking in here, and I'll get to that in a second. The concept of dispersion is when we think about a market's return, the individual securities in that market, the returns are dispersed around the market average. 

We've looked at our proxy for the market as the Russell 3000 since the early 1990s. As you can imagine, if you could visualize a chart, you'd see the growth in index fund assets being this linear uptick. If I said a simple way of thinking about dispersion is who are the stocks every year that outperform that market by 10 percentage points or more or underperform the market by 10 percentage points or more? 

I'm going to ask everybody right now in your head to think about on an average, there's a little bit of cyclicality, but it's basically a flat trend. What's the proportion of stocks in the Russell 3000 that can on average in a given year do better than 10 percentage points or worse than 10 percentage points? It's 70, 70% of the stocks, which number one tells me there is plenty of opportunity for active management to pick winners and avoid losers. 

Then the second reminder is, wow, indexing is a really great thing. Owning a broad market index fund eliminates that dispersion and lets you reap the benefits of the market's return.

Ben Felix: You're saying market volatility and dispersion have been relatively unaffected by the growth in indexing?

Jim Rowley: That's my position, yes.

Shelly Antoniewicz: Well, that's actually backed up by a recent paper by Chuck Fang. He also, doing econometric analysis finds that there's no problematic effect of index investing on volatility or the dispersion of individual stock returns.

Ben Felix: Tim, we've touched on this, but I want to hear your take. How are index funds affecting cross-sectional asset prices? This idea that there's an index fund bubble that's pushing the largest firms up larger and larger, what are your thoughts on that?

Tim Edward: Well, rather than take it to one academic versus another, since we're in the New York Stock Exchange, I think we can actually bring this all the way down to brass tacks with a thought experiment. Suppose you wanted to make a reasonably large position in a total market cap-weighted index. Suppose you wanted to put a billion dollars into a cap-weighted portfolio.

Well, 50 years ago, you would go downstairs with a program trade, and you would be allocating. You'd say, well, I want to put whatever it is, 7% in Apple, 6% in Microsoft, and so on down the list. Now, importantly, the weighting you have chosen for each stock is in proportion to the size of the outstanding stock and the outstanding supply of that stock.

That's why also we use pre-float in our index weightings, how much of it is out there available and trading. So your purchase will be run programmatically downstairs, but the extent to which you are taking the supply is perfectly matched in every stock. If the market cap was $100 trillion, it's not. 

But if it was and you were buying 0.1% of that, that means you're buying 0.1% of Apple's outstanding stock, 0.1% of Microsoft's, and so on and so on. Just as a thought experiment, it should be clear that your investment is not going to affect the price of the larger stocks compared to the smaller stocks in theory, right? But as a thought experiment, Apple has a higher weight than many other stocks in the index. 

The reason Apple has a higher weight than many other stocks is because active investors, people who weren't investing in market cap proportions, liked Apple more than they did all the other stocks. That's a really important fact. In fact, anything else except market cap weighting would be providing price information. 

But cap weighting is just benefiting from an incredibly chaotic consensus of people's views on what the fair value for all these securities are and not adding your own voice to that. So are there some large companies in the US right now? Yes, absolutely. 

Has it happened before? Yes, absolutely. Is it down to index funds? 

On just pure common sense basis, you know it doesn't make sense. There are various ways that you can see that supported in the data.

Jim Rowley: I'll tie together Tim's thought experiment with going back to Shelly's points about who owns index funds. We've done our own fair share of research to say, well, let's look at ownership of Russell 3000 companies and the proportion of shares held outstanding by US equity index funds. And I can't tell you how many times I show this chart to people I would call actually in the know about investing. 

And when we're able to show the highest proportion of ownership by index funds is in the mid cap space. It's not in the large cap space. And most find that to be like a shocking finding that when we are so laser focused on the largest of the large, you make the argument index funds collectively are actually underweight the largest of the large.

Shelly Antoniewicz: Well, even more than that. So if you look at the entire US stock market capitalization, index funds, index mutual funds, index ETFs, they hold 30%, 30%. There's still 70% over there that's not held by index funds.

Tim Edward: There is another thought experiment we can bring in because this is not to say that there isn't an impact between index related tools and price changes. We can keep it at the overall market level. But I do think there's an important point around the ability to trade whole market segments, sectors, et cetera. 

But we can keep it whole market. Overnight, while hopefully we're all asleep, you can actually trade other products tied to the S&P 500, options and futures that trade almost 24 hours a day, almost. And many in this room will be aware, and if you're not, let me tell you that it is the case that when the stock exchange opens downstairs, the price at which the securities open is typically very close to where the futures were indicating they should open. 

Now, that tells you something really important. It tells you that these index-based derivatives, futures and options, are acting as a mechanism for risk management and price discovery. So there is an impact on prices. 

But it is one where it is the same kind of impact that was traditionally happening with just individual securities. It is people with active views. It's people arbitraging. 

It's people expressing or managing risk. It's just that they are able to do so at a broad market level rather than running 500-program trades in 500 stocks.

Ben Felix: Whether index funds are the cause or not, Tim, how concerning is it, the current level of US market concentration?

Tim Edward: Thank you for giving me an opportunity to do a shameless promotion for what I hope you have picked up your partner's perspectives already. Because this is a really good question. And you can sort of split it. 

Is it worrying that the US equity market is rather concentrated? And should I do something about it? It is potentially worrying. 

And what you might decide to do about it may depend on the investor. But I do think the perspective offered by history is useful. So we are in a situation today where do top five, top seven, whichever you prefer. 

We looked at the top 10. And the top 10 stocks in the US represents a similar weight today, an almost 40%. The last time we saw that was in 1965. 

I can make the very clear observation. In 1965, there were no index funds. The first one came, thanks to Vanguard, 11 years later. 

No index funds, similar level of concentration. No index futures, no index options either, by the way. But what's interesting is if you look at the dynamics, the interaction over time, we measured how did concentration change? 

How did market performance change? It is not the case that high concentration is definitely a bad thing for markets. It is the case that concentration tends to decrease and increase over time. 

The fascinating piece is you might think if concentration decreases, that means the larger stocks do badly. And if the larger stocks do badly, that must mean that the equity markets have collapsed. But it's not necessarily the case. 

And actually, what you see is far more interesting. What can happen is, if you like, a changing in the guard. The current heroes may decline, but the next generation may already be in the index. 

And their gains can be extraordinary. And they can take over the job and the role of carrying the markets forward. Has that started happening already? 

I don't know. So far this year, we have seen a broadening of market returns. It's very early right now to say. 

But there's certainly a sense of disruption, creative destruction in equity markets. And that dynamic, allowing the big guys to fail in order to allow others to rise and take their place, is not so much a feature of indices. Indices reflect that.

It's a feature of the capital markets. Long story short, the message would be high concentration in itself can be concerning, but it doesn't have to be.

Ben Felix: We've been here before, and returns have continued to be fine. I'd love to hear from each of you what message you have for people who are concerned about these things, about index funds affecting the quality of financial markets and causing, if we believe that, high concentration. Shelly, we'll start with you.

Shelly Antoniewicz: I'm just going to go back to saying, look, there's been a lot of research done on this. There's no clear-cut answer. There's studies that say this. 

There's studies that refute that. Another piece of evidence against index funds having an impact on the markets or a negative impact on the markets is, do you remember index inclusion? You would bring a new stock into the index. 

That stock would get a bump, a temporary bump in returns because it's now in the index. That shrunk dramatically over time. And that shrunk because we've got more arbitrage opportunities and active managers that are more efficient. So there is no more equity index premium.

Tim Edward: It goes back to the point about the way that indices evolve with the marketplace that's using them. We, S&P Dow Jones Indices, actually changed the way that we communicate changes in our major indices. I don't know if anyone in this room was still operating at the time, but more than 20 years ago, the case was that we would tell you after the close of the equity markets what you should have bought just half an hour ago. 

Sounds like a small, very technical thing. We changed it so that we would tell people in advance. Now, in theory, that sounds like, by the way, I say tell people, distributing that information to the entire market at the same time. 

But that actually changed the dynamics of the way that the people tracking index funds rebalanced. There was a large community of individuals and traders and so on and shops who were then keen to own the stocks that would be bought by index trackers and sell it to them, hoping to benefit from this pop in price. But it's very difficult to distinguish that which might feel somehow predatory. 

But if you actually look at what they're doing, they are serving the needs of liquidity of people tracking indices. They are buying the securities that people tracking in the indices are going to want to buy. And what's happened is that has become an incredibly competitive marketplace. 

And that is why, whereas it used to be 6% to 8% pop, statistically, that's now to basis points. It's a tiny, tiny bump because of the transparency improvement. But it's also because of the interaction between users of index products, fund companies who are managing their index exposures, the level of transparency provided by the index provider, and the market awareness of those dynamics.

Ben Felix: More indices, too, I think. Stocks are moving from one index to another. It doesn't have as much of a price impact.

Jim Rowley: Can we please remember the consumer choice element of index funds? Putting aside all the market talk, there's an economics lesson here. Consumers have chosen to buy a product that they believe to be of superior quality at a better price. 

And if everybody can indulge my soapbox, unlike a car where maybe price and quality are independent, with investment products, quality is a function of the price. And I wish everybody thought more in terms of like, this is consumer choice. Consumers, i.e. investors, have outwardly selected index funds because they believe they are better quality at a better price.

Ben Felix: Tim, do you have a parting thought for the haters?

Tim Edward: First, I'll echo Jim. I think it's a line from Jack Bogle. You get what you don't pay for. 

But don't just take our word for it. Look at the statistics. I mean, we put out an annual scorecard for the active industry. 

Our latest statistics were 94% of actively managed US domestic equity mutual funds underperformed the S&P 500 over 20 years. 94%. So those are the odds. 

But the conclusion is, it's supporting the choice point. If you want to try and beat the market, you want to join the police, great, brilliant. But the availability of a choice to just participate in market gains is worth a lot to those people who have benefited from it.

Ben Felix: Awesome. Thanks, guys. That's all the questions I have. I thought that was a great discussion. For the six of us who are still listening, four of us here, I guess there's-

Ben Wilson: Two listeners.

Ben Felix: At least two more people, I hope. What did you guys think of the panel?

Cameron Passmore: I thought it was great. That was interesting, well-spoken, understandable. I thought your questions were good. 

First, I think you do a great job. You're totally calm and brought out good questions. So I thought it was well done.

Ben Felix: That was a fun thing to do. Cool to be talking to those people. Cool to be invited.

Cameron Passmore: That's good to build your exposure in that community too, which is nice. Nice that they reached out to you. It's a great compliment.

Ben Felix: I think that's probably because of when we had Jim early on the podcast. He was thinking, who do I know that could moderate a panel discussion about index investing?

Dan Bortolotti: So was this event a whole day?

Ben Felix: It was the morning. It was like 8 AM until noon or something like that. I flew in the night before and then flew out the next afternoon.

Dan Bortolotti: How were the other speakers?

Ben Felix: There was a whole bunch of people. I'd have to go and look up the agenda to tell you all of them. There was four panels and each one had multiple speakers.

Ben Wilson: Wow. Nice. 

Ben Felix: That was cool. Okay. After show, here we go. 

We have a bunch of comments. Jeez. Anything else, Cameron? 

People say that they miss your chitchat, your book recommendations, your shows. What do you got?

Dan Bortolotti: Putting him on the spot.

Cameron Passmore: Oh, what have I got? Not a lot of shows. 

I don't watch a lot of TV anymore. Listen to a lot of podcasts, actually. I confess I'm loving The Daily from the New York Times, which I'm sure a lot of listeners check out regularly.

I like the deep dives into topics, which is good. I confess we're watching Love is Blind. Judge me not. 

I'm just coming clean and I'm pretty sure I'm the only one on this panel that is.

Ben Wilson: You have a lot of guilty pleasures. You're also watching the Golden Bachelor and 600 Pound Life was one of your go-to shows for a while.

Cameron Passmore: All the secrets. I want to save some. Benjamin, we're going to dig into your watching habits still. 

Ben Wilson: This is about you, Cameron.

Cameron Passmore: Yeah, it's about me. Main thing in this one has been a lot of skiing. 

What a ski season in Laurentians and Quebec. Wow. Compared to out west, I don't know if you've talked to people who've been skiing out west.

Ben Felix: Oh, yeah. No snow.

Cameron Passmore: Talked to someone who went to Vail last week. It's like no natural snow in Vail, which is just devastating for some of the areas. Eastern Ontario, western Quebec has been phenomenal. Just like the perfect ski season.

Ben Felix: Nice winter weather for sure.

Cameron Passmore: How about you, Dan? What do you do in the winter?

Dan Bortolotti: Well, geez, this is the coldest winter we've had here in Toronto for years. I mean, we had minus 20 Celsius for probably two weeks without much of an interruption. It's finally warmed up in the last few days. 

I've been getting outside again, but it was too cold to ski for sure. That's long chairlift ride in 20 below zero with wind chill. It was mostly indoor activities.

Ben Felix: Yeah, it got cold. Out where I am, we had some below the minus 30s, like minus 32, minus 33. Had to worry about the well line freezing. It was cold.

Cameron Passmore: Oh, the well line. Back to your happiness place. Home ownership.

Ben Felix: Yeah.

Cameron Passmore: Sorry I let you down. I'll come better prepared next time.

Ben Felix: That was great. That's the juicy stuff that people want to get from you, Cameron.

Cameron Passmore: Oh, juicy. I appreciate the follow-up, Ben Wilson. That's very kind of you.

Ben Felix: Ben Wilson, he's vicious, man.

Ben Wilson: Vicious?

Ben Felix: You let your guard down for a second, you're cooked.

Dan Bortolotti: Oh, he'll get you. Don't tell him what you eat because that'll show up in a future episode as well.

Ben Wilson: It's all fair game around here. You guys dish out your own fair share.

Cameron Passmore: Yeah, but not on a podcast.

Ben Felix: Okay. We have some reviews from Apple podcasts to read. Under SEC regulations, we're required to disclose whether a review, which may be interpreted as a testimonial, was left by a client, whether any direct or indirect compensation was paid for the review, or whether there are any conflicts of interest related to the review. 

As reviewers are generally anonymous, we are unable to identify if the reviewer is a client or disclose any such conflicts of interest, but we do have four reviews. Dan, you want to take the first one?

Dan Bortolotti: This one says, "a gem of truth and nuance in a sea of financial slop." That's a great headline, by the way. "Absolutely brilliant show and great to see that the best finance podcast anywhere is hosted by two and sometimes more Canadians. 

Sad at the lack of after show lately, hopefully the six of us that listened to it will be coming back soon. Would love an episode discussing planning in the context of mixed currency compensation for Canadians, especially those who receive CAD and Euros and USD." That's an interesting one we haven't done yet.

Ben Felix: That is an interesting one.

Ben Wilson: Cool topic idea.

Ben Felix: I'm glad that we satisfied the need for an after show with this episode.

Dan Bortolotti: For the six of you.

Ben Felix: For the six of you. Cameron, you got the next one?

Cameron Passmore: Sure. Review slash question. "This podcast is phenomenal.

I have been listening for over a year and look forward to Thursday mornings to catch the latest episodes. The reliance on evidence to drive portfolio construction is refreshing. I'm coupling this review with a question. 

I'm curious to know what clients of yours are invested in the five factor model portfolios that you announced years ago, because the premiums can take a while to capture. I guess I'm curious as to if there is a preferred time horizon, number of years the dollar is to be invested for this model portfolio to be implemented for a hypothetical client."

Ben Felix: For us, the vast majority of our clients are in dimensional portfolios. Larry Swedroe, when he was a guest, super early on in the podcast, we asked him that question. He said that people get this backwards, that the premiums, because they increase the reliability of the outcome, because you have more premiums that could show up to help you. 

For shorter horizons, his claim at the time was that it's actually better to have more factor exposure if you have a shorter horizon. If you're just exposed to the market and the market goes through a long period of underperformance, which has happened many times throughout history, that's not so good. That goes away with geographical diversification with a market cap weighted portfolio. 

I don't think factor exposure is very sensitive to time horizon. If someone's retired, probably still makes sense. If someone needs their money in five years, they probably shouldn't be invested in a stock portfolio period, but I don't think that the decision to tilt toward other asset pricing factors other than market beta, I don't think that's very sensitive to your time horizon. 

If you can be investing in stocks, I think you can be investing in a factor tilted portfolio. What do you guys think?

Dan Bortolotti: I'd agree with that. Yeah, the factors can take a while to show up, but you could say that about the market factor, which is the overwhelming one.

Ben Felix: Larry's point was that, what you just said, Dan, and that if you look historically, if you go look through the data, having just the market, you've got a higher chance of having one of those longer periods of poor returns than if you are tilted toward some of the factors. Now, factors had gone through, they started to come back. They went through a long period of underperformance recently, so maybe that's what people are anchored to, but it happens with the market too. 

It's been a while since we've had a long drought of equity returns, but it certainly does happen.

Ben Wilson: No kidding.

Ben Felix: Ben, you get the next one.

Ben Wilson: "Loved the episode with Nick Maggiulli. I especially liked it when you guys talked about the 0.01% rule, which allows you to stop sweating those tiny marginal spending decisions. It made me feel okay about always springing for the cage-free eggs now, even though I probably should have stopped worrying about the $5 difference decades ago. Thank you so much, Ben."

Ben Felix: Was it just me that interviewed Nick that time? I think it might have been.

Cameron Passmore: No, I think I was there.

Ben Felix: Why didn't he thank you then

Cameron Passmore: Yeah, you're more important. That's okay.

Ben Felix: It's funny. 0.01% rule is cool. It's like if you're going to spend something, spend money that's less than 0.01% of your, I can't remember if it's your net worth, then you shouldn't sweat it.

Cameron Passmore: It's your net worth, so it's 3.65% per year.

Ben Felix: People in the Rational Reminder community skewered that idea though, because it's like, 0.01%, but how do you limit that? What if you just keep justifying 0.01% expenses, they stack on top of each other, and all of a sudden it's a higher percentage of your net worth and you're cooked.

Cameron Passmore: If it was at one time, not recurring. Recurring would not be included in that.

Ben Felix: So 0.01%, is it per day though, or per decision?

Cameron Passmore: Every day, you get 0.01%. That's 3.65% per year. It's basically breaking down that as a safe spending rule divided by 365.

Ben Felix: Cool. Having a rule for "don't sweat this expense" does make a lot of sense. Nick's point in that episode was that people need to shift their thinking as their wealth bracket changes over time, which I think is very sensible. 

I think a lot of people do get caught living outside of the way they should be living based on what their financial situation is.

Ben Wilson: That's compounded by the common analogies that a lot of people use. Like, if you stop spending $6 a day on Starbucks, imagine how much money you could save. If you got $5 million, it's probably okay to spend $6 a day on Starbucks. 

But some clients, I've seen the behavioral changes in them. They still are wary of spending $6 on Starbucks, even though they're at a point of financial independence. They worry about, can I do this or not? 

It's hard to comprehend what your wealth means sometimes.

Ben Felix: I've heard some funny stories about stuff like that with very wealthy people who won't pay for parking close to a sporting event, stuff like that. Anyway, last review, ETFs potentially useful. "First of all, I'm a massive fan and have been listening to the podcast for more than two years now, and I think you're one of a kind. 

Small criticism slash feedback. It's been a while since we had a really nerdy mathsy podcast." All right. 

I'm guessing we got Hendrik Bessembinder coming up.

Cameron Passmore: I was going to say, that'll be taken care of pretty soon.

Ben Felix: That may be before this, I think. Bessembinder is before this episode comes out. By the time this comes out, that's a mathsy episode. 

You want mathsy, there you go. We've got James Choi coming up too. That's also going to be mathsy. 

We got you covered, I think. "I work in the industry as a quant in a hedge fund, so I'm aware of some of the topics from the other side as well. Now to my point, I have two SIPP accounts. 

These are the tax-free pension accounts in the UK, and you cannot withdraw from them until age 55. They both charge a management fee. One is at 0.45%. The other one is at 0.25%, which gets better at over 1 million pounds. However, for your ETF and shareholdings, the annual fee is capped at 230 pounds and 120 pounds respectively. I opt for a combination of ETF trackers giving me global exposure equivalent to FTSE All-World with a home bias. Can you think of any reason anyone should hold anything else than ETFs with a portfolio of 100,000 pounds or more?" 

Then they list the providers. I don't know if I fully understand the question there, but is there a reason to hold something other than ETFs if you have a larger portfolio? I think it ties back to our discussion about institutions in the introduction. 

I think people tend to have a bias toward complexity, particularly as they have more capital to invest. It's just like there's no way that how I was investing at $10,000 still makes sense at 100,000 or a million or 100 million. I honestly think that simplicity is better than complexity at any level of net worth, at any level of investable assets. 

It's a very expensive misconception that people get caught in where they think they must have to change what they're doing because they have more money to invest, but that's what the people selling the expensive financial products, they will want you to think that. That's really good business for them, but the evidence on that stuff being objectively better, I don't think it's very strong. Hopefully, that's the question that this listener was asking, but I don't know if you guys interpreted what they wrote differently.

Dan Bortolotti: I would agree with that. Certainly, if you're talking about individual investors, there might be a point where you could make a good argument that it makes sense to diversify beyond traditional index funds, but it's not at the individual level. I think we're talking at the institutional level, right? 

Even if you've got two or $300 million, you could probably invest in a portfolio of index funds and be just fine. Maybe if you're a pension plan and you manage $20 billion, you could make an argument that there are opportunities that you can diversify into private equity and infrastructure and all these things that are just off the table for individuals, but I've had people say to me, indexing doesn't make sense after 5 million or 10 million. That's a lot of money for an individual, but in the scheme of things, it's not that much money and the market can absorb your 5 to 10 million just fine. 

There's no dearth of opportunities when you're talking about numbers like that. The reader here is talking about individuals, and I think the answer is no. There's no compelling reason to hold anything other than a portfolio of index funds at the number he gives is 100,000 pounds. 

It's not a mind-blowing sum of money.

Ben Felix: Even for institutions, we hear those points that you made there, Dan, but then you go and look at the returns of institutions of pensions that are saying like, hey, we've got these opportunities that aren't available to retail investors. I'm not going to name names of the pension funds here, but a lot of them have not performed very well relative to the index. I think there are probably arguments unrelated to asset only performance. 

If you have real long-term liabilities and you're required to keep pace with those, that's probably a stronger argument to do other stuff that may, for whatever reason, be more closely related to inflation. If you need to hold a certain type of asset that is going to be well-matched to your specific liabilities and you can't get that in public markets, I buy that argument. The argument that there are special opportunities for even the largest pension funds, I'm not convinced that's true because the data do not support it at all.

Dan Bortolotti: I certainly wouldn't argue the point too much. I think it's a reasonable expectation, but yeah, if you're pointing out that a lot of very large pension funds, for example, underperform basic benchmarks because the active part of their portfolio doesn't outperform.

Ben Felix: Including the private stuff. A lot of promises were made about those asset classes over the last 20 or so years. I don't think any of them have been delivered on. 

All right, that's it for the reviews. Anything else? Any parting thoughts?

Dan Bortolotti: I don't think so.

Ben Wilson: 400 is pretty cool.

Ben Felix: A bit of a different formula for our 400th episode. We had our little preamble or whatever, the after show, plus a panel, which we've never done that before. At least not quite like this. 

Hopefully people enjoyed it, but you can let us know in the comments or in the Rational Reminder community.

Dan Bortolotti: Congrats, guys, on 400. It's pretty impressive.

Ben Wilson: Very well done.

Disclaimer:

Portfolio management and brokerage services in Canada are offered exclusively by PWL Capital, Inc. (“PWL Capital”) which is regulated by the Canadian Investment Regulatory Organization (CIRO) and is a member of the Canadian Investor Protection Fund (CIPF).  Investment advisory services in the United States of America are offered exclusively by OneDigital Investment Advisors LLC (“OneDigital”). OneDigital and PWL Capital are affiliated entities, and they mostly get on really well with each other. However, each company has financial responsibility for only its own products and services.

Nothing herein constitutes an offer or solicitation to buy or sell any security. Occasionally we tell you not to buy crappy investments in the first place, but that’s not the same thing as telling you to sell them.

This communication is distributed for informational purposes only; the information contained herein has been derived from sources believed to be “truthy,” but not necessarily accurate. We really do try, but we can’t make any guarantees. Even if nothing we say is fundamentally wrong, it might not be the whole story.

Furthermore, nothing herein should be construed as investment, tax or legal advice. Even though we call the podcast “your weekly reality check on sensible investing and financial decision making,” you should not rely on us when making actual decisions, only hypothetical ones.

Different types of investments and investment strategies have varying degrees of risk and are not suitable for all investors. You should consult with a professional adviser to see how the information contained herein may apply to your individual circumstances. It might not apply at all. Honestly, you can probably ignore most of it.

All market indices discussed are unmanaged, do not incur management fees, and cannot be invested in directly. Which is a shame, because it would be awesome if you could.

All investing involves risk of loss: including loss of money, loss of sleep, loss of hair, and loss of reputation. Nothing herein should be construed as a guarantee of any specific outcome or profit.

Past performance is not indicative of or a guarantee of future results. If it were, it would be much easier to be a Leafs fan.

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Is there an error in the transcript? Let us know! Email us at info@rationalreminder.ca.

Be sure to add the episode number for reference

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Participate in our Community Discussion about this Episode:

https://community.rationalreminder.ca/t/episode-400-the-evolution-of-index-fund-investing/41611

Links From Today’s Episode:

Stay Safe From Scams - https://pwlcapital.com/stay-safe-online/

Rational Reminder on iTunes — https://itunes.apple.com/ca/podcast/the-rational-reminder-podcast/id1426530582.

Rational Reminder on Instagram — https://www.instagram.com/rationalreminder/

Rational Reminder on YouTube — https://www.youtube.com/channel/

Benjamin Felix — https://pwlcapital.com/our-team/

Benjamin on X — https://x.com/benjaminwfelix

Benjamin on LinkedIn — https://www.linkedin.com/in/benjaminwfelix/

Cameron Passmore — https://pwlcapital.com/our-team/

Cameron on X — https://x.com/CameronPassmore