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Cliff Asness

Indexing Is Capitalism at Its Best

Piggybacking on prices developed by other people is fine. That's how free markets work.
Free marketeers.

Free marketeers.

Photographer: Kevin Mazur/wireimage/getty images

A recent Sanford Bernstein research report titled “The Silent Road to Serfdom: Why Passive Investing is Worse Than Marxism,” besides starting quite the kerfuffle in the financial world, raises some eternal questions. For instance, if you stumbled upon any random group of finance Ph.D. students at 2 a.m. in the student lounge having finished all the Michelob Light they lifted off the MBA mixer, there’s a good chance you would hear one of them say, “Hey, if everyone indexed what would happen?” and then witness a long but ultimately unproductive discussion on the topic. More subtle, alternative versions of the question would be: What’s the right amount of active management for investors and for society in general (and is the answer the same)? What’s the fair fee for such services? How efficient are markets? If markets are not perfectly efficient, and they most assuredly are not, what’s the efficient amount of inefficiency? Do correlations go up as a result of indexing?

These are all good, fun and important questions, but I won’t be addressing them here (much).  Instead, my goal is much simpler. The Bernstein note  missed, or at least minimized, something much more important about prices. Free riding on price signals isn’t a bug of capitalism to be exploited by those greedy red indexers; rather, the use of price signals by those who played no role in setting them may be capitalism’s most important feature.