After decades of passive index funds and index-linked ETFs as the retail and institutional investment vehicles of choice for public markets, now the background market conditions underlying their rise have gone through drastic change – raising the question of how viable they still are. All the same, index providers have reacted with commendable alacrity to the current environment.
For connoisseurs of volatility, there’s the Cboe Volatility Index (VIX), otherwise known as “the fear index”, which US market trackers have been assiduously following since the advent of the current administration. Spot indexes have been launched in areas such as air cargo, to offer ways of tracking the new levels of volatility in the sector. Other leading index providers have launched offerings advertising “volatility-control innovation”, incorporated into indices, designed to offer reduced volatility through intraday rebalancing and other techniques. Indexes and funds designed from the ground up to limit volatility have shone in the current market environment. And against the US market selloff, Morningstar boasted in April that its “Morningstar US Low Volatility Factor Index has held its value, while other benchmarks tracking common stock characteristics are deep in the red”.
Some critics, past and present, have blamed index funds for amplifying or even causing volatility, when retail and institutional investors alike make redemptions, transfer allocations, and otherwise react in sync to developments. Some minds may hark back to the so-called 2010 “flash crash”, caused predominantly by automated trading and other mechanisms since (hopefully) corrected. Some investors probably wish that machine errors were still to blame for the current volatility.
Perhaps it’s worth remembering what made index investing so popular in the first place. The thesis that it’s ultimately impossible to beat the underlying market long-term is one thing; the reality that such a belief allowed for very low-cost low-maintenance investment instruments is quite another. Macroeconomic developments, not market instruments, create volatility, past and present. Market instruments simply exhibit and echo it.
Simple passive index tracking is all very well in an environment of steady and predictable growth. In an environment experiencing more upheavals, whether short-term or representative of historic secular trends, more active repositioning and analysis may well be required – and that is almost certain to cost money. Investors are simply going to have to swallow this cost or lose money. They have been managing to square this circle for an inordinate amount of time – now fundamentals finally appear to have moved definitively against them.
