The 5 Most Important Passive Developments of 2019

A 2019 journal.

Passive investing made significant progress in 2019. In fact, some might argue that 2019 was the most disruptive year in ETF investing yet.

This has raised many questions among the self-directed investment community. How should investors approach passive investing moving forward? What major trends do they need to be made aware of?

In this article, we explore the 5 most important passive investing developments of 2019.

Honorary Mention: The Passing of Jack Bogle

Jack Bogle - the founder and longtime chief executive of the Vanguard Group - was the creator of the first index fund. He was an avid educator with a relentless focus on reducing the aggregate costs paid by the investment management industry.

Warren Buffett once said that “Jack did more for American investors as a whole than any individual I’ve known. A lot of Wall Street is devoted to charging a lot for nothing. He charged nothing to accomplish a huge amount.”

Bogle died on January 16th of this past year at his home in Pennsylvania. This article is dedicated to his legacy and everything that he has accomplished for investors everywhere.

5. The Explosion of Indexes

The first trend worth discussing in this article is the increased prevalence of financial indexes - groups of stocks (or other securities) that ETFs and other investment products are benchmarked against.

Remarkably, 2019 saw the creation of more investing indexes than ever before. In fact, according to the Index Industry Association, there are approximately 3 million different financial indexes available today.

The dispersion within the data is interesting; non-traditional indexes like fixed income indexes and ESG indexes have been surging as a category, while the largest category - equity indexes - is actually decreasing (albeit at a slower rate).

Moving forward, it is highly likely that we will continue to see a growing number of indexes for investment managers to benchmark their new products against in the future.

4. The Introduction of Non-Transparent ETFs

Since inception, ETFs have been required to make their current holdings available to current and prospective investors. This was typically done through a website interface. As an example, you can see the fund facts (including holdings) of the world’s largest ETF - the SPDR S&P 500 ETF Trust, which trades under the ticker SPY - here.

2019 saw this holdings disclosure rule change forever. This year, the SEC approved the introduction of a number of new ETF formats, including non-transparent ETFs where the holdings do not need to be shared with the public.

Some have argued that this will help active ETF managers like Alpha Architect implement their strategies without their ideas being diluted by outside market participants. Others, such as Morningstar’s Ben Johnson, have argued that the introduction of non-transparent ETFs may not be the tailwind that active managers are expecting.

Whatever the outcome, this material change in regulation paves the way for some interesting developments.

3. The Continued Adoption of Passive Investment Strategies

2019 saw the continued rapid adoption of passive investment strategies and corresponding outflows from their active - and more expensive - counterparts.

For evidence of this trend, look no further than research from Moody’s that suggests passive investing is likely to overtake active investing as early as 2021.

Among this increased adoption of passive investment strategies is the rise of certain investment managers - perhaps most notably Vanguard and BlackRock. According to Institutional Investor, Vanguard controlled about one-quarter of the entire domestic investment management industry.

In 2020, we believe that the increased prevalence of passive investing (as well as even higher market share for the largest passive investment management firms) is a trend that is highly likely to continue.

2. Continued Industry Consolidation

The investment management industry has been consolidating for decades, which - as we mentioned earlier - has caused certain players to rise to significant market shares within the industry.

Another way that this trend materialized in 2019 was when TD Ameritrade and Charles Schwab announced a merger set to transform the industry. More specifically, Charles Schwab is set to acquire TD Ameritrade for $26 billion in an all-stock transaction that will create a mega-broker with more than $5 trillion in assets under management ($3.8 trillion from Schwab and $1.2 trillion from TD Ameritrade.

The merger is expected to close in the second half of 2020. TD Ameritrade shareholders will receive 1.0837 shares of Schwab stock for each share of TD Ameritrade owned prior to the announcement.

Looking ahead, the asset management industry is experiencing a wave of change that makes it difficult to make accurate predictions. Despite this, we believe continued consolidation (similar to the TDA/Schwab transaction) is highly likely moving forward.

1. The Year of Zero Fees

While some have argued that low-cost ETFs have essentially been free for years because of the revenue offset from securities lending programs within the funds themselves, the trend of zero-cost investing made significant progress in 2019.

In October, brokers raced to the bottom of the fee pool as Charles Schwab, TD Ameritrade, and E*Trade Financial Corp. all announced zero-cost trade options. The investment community punished brokerage stocks due to fears about the longevity of their business models, wiping $16 billion in aggregate market capitalization across the three fee-cutting businesses.

Interestingly, some analysts have hypothesized that Schwab’s fee cut (which came first) was partially a strategy to drive TD Ameritrade’s stock price lower prior to the announcement of their acquisition.

Schwab generates significantly less of its revenue from brokerage commissions than TD Ameritrade does, which gives it a better competitive position in a world of zero trading fees - causing TD Ameritrade’s stock to fall.

Final Thoughts

This year was a busy one in the world of passive investing.

With that said, some things are bound to stay constant over time in investing. Low fees, periodic rebalancing, and a hands-off investment approach are cornerstones of our approach at Passiv. Try our community edition for free today and turn your portfolio into your own robo-advisor now.

Written by Nick McCullum

December 31st, 2019