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The Dark Side of Passive Investing

The Dark Side of Passive Investing

15-11-2014 | Research
Passive investing ranks among the most successful innovations of modern finance. Yet there is also another side to passive investing, which the discussion often seems to ignore.
  • David Blitz
    David
    Blitz
    Head of Quant Research

Speed read

  • Passive management is an appealing concept
  • But this approach also comes with serious flaws
  • Active investors can benefit from factor premiums
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Should passive investing be encouraged, for the time being, or are we perhaps already at a point where discouraging passive investing would actually be more appropriate? In this article,1 we argue that, at the very least, the proponents of passive investing should seriously address the broader implications of their approach.

First, they should acknowledge that large-scale active investing is a prerequisite for passive investing, as well as for an efficient allocation of capital. Second, they should describe how large-scale passive and large-scale active investing can coexist in a macro-stable equilibrium. Third, they should identify who should invest actively in this equilibrium, as well as their own roles and responsibilities.

These considerations might be called the sustainability dimension of passive investing. Interestingly, investors increasingly demand that the companies in which they invest adhere to sustainable business models. Perhaps the sustainability of their own investment philosophy ought to be put to at least the same level of scrutiny.

1Blitz, D.C., 2014, ‘The dark side of passive investing’, The Journal of Portfolio Management.

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