Has Index Fund Growth Impaired Markets?
The rise of index funds raises concerns that less active analysis could lead to an increase in mispriced securities in the market.
One common concern about the increasing popularity of index funds is whether the corresponding decline in active management has impacted the function of markets. The premise is that a higher proportion of assets in index funds means fewer non-index investors devoting resources to analyzing securities, thereby increasing the chances of mispriced securities.
If the rise in indexing was producing low-hanging mispricing fruit, it sure isn’t showing up in the performance of actively managed mutual funds and ETFs in the US. Even as the percent of index assets has expanded—jumping from 32% to 58% in just the past 10 years, according to ICI’s 2024 Fact Book—the percentage of active equity funds outperforming their benchmarks over rolling three-year periods has not changed by much.
It’s debatable whether index fund assets should be equated with passive behavior. And judging by the active fund landscape, it’s hard to argue markets are any less effective at incorporating information into prices.
EXHIBIT 1
Active Manager Performance Has Not Improved
Percentage of non-index equity funds outperforming over rolling three-year periods, 2004–2023
Appendix
Data Sample
The sample includes US-domiciled, USD-denominated open-end and exchange-traded funds (ETFs) in the Morningstar categories listed below. Index funds, load-waived funds, and funds of funds are excluded from the industry sample.
Methodology
Equity mutual fund outperformance percentages are shown for the three-year periods ending December 31 of each year, 2004 through 2023. Outperformers are funds with return observations for every month of the three-year period whose cumulative net return over the period exceeded that of their respective primary prospectus benchmark. The beginning samples include funds as of the start of the three-year periods. Each fund is evaluated relative to its primary prospectus benchmark. Where the full series of primary prospectus benchmark returns is unavailable, funds are instead evaluated relative to their Morningstar category index. We aggregate funds with multiple share classes to the strategy level.
Morningstar Categories
Fund sample includes the following Morningstar historical categories: Diversified Emerging Markets, Europe Stock, Foreign Large Blend, Foreign Large Growth, Foreign Large Value, Foreign Small/Mid Blend, Foreign Small/Mid Growth, Foreign Small/Mid Value, Global Real Estate, Japan Stock, Large Blend, Large Growth, Large Value, Mid-Cap Blend, Mid-Cap Growth, Mid-Cap Value, Miscellaneous Region, Pacific/Asia ex-Japan Stock, Real Estate, Small Blend, Small Growth, Small Value, Global Large-Stock Blend, Global Large-Stock Growth, Global Large-Stock Value, and Global Small/Mid Stock.
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