Passive investing, which involves tracking a market index such as the NSE 20 Share Index and buying into and holding assets for a long time without often trading, has become popular over the years with products such as index funds and Exchange – Traded Funds (ETFs) becoming common in modern portfolios. They are appealing to investors due to their simplicity, lower fees and long-term stability. Also, it has made investing more accessible to the ordinary person. However, as more flock towards these instruments, concerns that passive investing is diminishing the competitiveness of the market and distorting price discovery are arising among experts such as economists and asset managers.
In developed markets, this strategy has proved successful by outperforming many active funds. Passive investing is trending in emerging markets such as Kenya, where products such as the ABSA NewGold ETF (GLD) are gaining traction. Critics are skeptical towards passive investing as they believe that index funds allocate capital based on market capitalization making them biased towards large and established companies while overlooking upcoming companies that are not yet part of the index. This can lead to consequences such as limited capital for startups since more capital is flowing to indexed funds leaving less for smaller firms and high concentration risk among the blue-chip firms making the market vulnerable to shocks in these sectors. Passive investing leads market inefficiencies when a large share of the market is passively managed, less investors will engage in active price discovery which will weaken the market’s ability to reflect the true value of companies
Proponents of passive investing argue that it is cost effective, meaning investors will retain more of their returns, transparent and simple because the investors already know what they want in the market. They also argue that their performance is consistent since they outperform active managers over the long-term even after deducting fees. Passive investing has made investing more accessible to normal individuals globally, including those in developing nations like Kenya. Passive investing provides liquidity in volatile markets by providing investors with easy entry and exit rights. By providing investors with a broad option of products to invest in, they can easily benefit from diversification. This spreads risk and reduces the probability of failure of a company.
Passive investing may be modifying financial markets, but it is not undermining innovation. However, it is changing the flow of capital and the finance industry is being forced to evolve and adapt. A suitable balance between active and passive investing may be the best strategy going forward ensuring that markets remain efficient while giving innovation the space it needs to thrive
