There is no doubt that I do think that most of the investors who are reading this blog should index their portfolios. However, there are too many of us who will tell you that ‘you’ should index but we know how to invest. I guess this hurts egos! So the mutual fund industry thrives, and many of us are of course not complaining.

One question that gets asked is ‘what happens if everybody indexes their portfolios’? will the market get more efficient or less efficient.

So first of all let us not confuse indexing with the passive indexing that all investment experts ask you to do. There is a new animal called the ETF. The exchange traded fund is perhaps more active than many fund managers in the so called ‘active’ space. These are the fund managers who constantly keep looking for disparity during the day between the underlying assets and the index itself. These are the active people who are making YOUR passive index efficient.

When a fund manager sitting in NY is bullish on India he does not do much. He buys say a Sensex etf or a Nifty Etf. And does the reverse when he wants to go short. At this time there could be buying in say Infosys and selling in Tata Motors. As a passive index watcher and investor you do nothing, but the etf manager will be busy seeing whether to be buying some of the underlying too in some other fund!! The index is largely ‘information’ and ‘information backed by money’.

See the profitability of HFT (High Frequency Traders) and banks with wealth advisory business, and you realize that there is a lot of money to be made in dealing with the underlying securities, just to give YOU a well discovered price. Also as more and more people index, specialised funds like ‘infra fund’ and ‘pharma fund’ will have to disappear (because people are not investing in them) or become more popular because of their lumpy returns!! All this will push some money out of the index – because there will always be people on the fringes who will want to do ‘something different’. So your value funds, growth funds, sectoral funds will all put pressure on the index funds!! So indexing will get more popular, but will actually increase he challenges for the active fund manager. The more the active fund managers, the better it is for the indexers!! Oops. A little heady, no?

Indexing is meant for the lazy. Which will mean that there is a lot of scope for the ETF guys who are good at market making. IN the process they make lots of money for their clients. QED.