Buying the haystack rather than looking for the needle

The debate over whether investment fund managers beat the market or not is as old as the profession itself. However, until 30 August 1976, there was no alternative. You either invested on your own or entrusted your money to an investment fund manager.

For almost exactly 50 years to the day, this alternative has existed, thanks to John Bogle. He is regarded as the father of index investing. Through his company, Vanguard, he launched the first investment fund tracking the US S&P 500 share index. For the first time, it was possible to buy an entire index in one go with a small amount of money. Or as Bogle himself put it: “Don’t look for the needle, buy the haystack.” Was it a sure-fire success from the outset?

A long lean spell

Far from it. Vanguard had hoped for an initial volume of between 50 and 150 million US dollars, but only 11 million were raised. By the end of May 2026, the successor to that original investment fund was managing US$1,700 billion, making it just one of many passive investment funds. The idea gained further momentum when, in the 1990s, such investment funds began to be traded on the stock exchange, giving rise to ETFs (Exchange-Traded Funds).

Investment funds that track an index are described as passive. “Passive” means that no fund manager decides which equities are better or worse. It is solely the composition of the index that determines which equities are bought. In most cases, the criterion is market capitalisation.

Many in the financial markets were sceptical of Bogle’s idea; some even found it un-American, because investors would, from the outset, be aiming “only” for the market average. However, the vast majority of fund managers – we’re talking about 75 to 85 per cent, or even more depending on the market segment – do not achieve better returns than the index over the long term. Since 2024, more money has been invested in passive investment funds than in active ones in the US. Could this perhaps become a problem?

Two aspects give cause for thought. The first can be illustrated using the example of SpaceX equities. This initial public offering in June once again highlighted the dependence of index tracking. After all, it is solely up to the index provider and its rules to decide when a share is included in the index. SpaceX equities have been included in the global MSCI Index since the end of June. With new equities in particular, the share price fluctuates wildly at the outset because nobody knows exactly where the price stands. However, because the equities are included in the index, passive investment funds are forced to buy them. Although the weighting in the index is minimal, this nevertheless highlights the problem with passive investment funds: they are only as good as the index.

Who sets the price?

The second aspect is somewhat more theoretical. If passive investment funds become dominant in markets, price discovery could suffer. Equities prices would then only change when these investment funds buy or sell, depending on whether they are experiencing inflows or outflows. When will this tipping point be reached? Nobody knows. At any rate, “incorrect” prices – such as a share being undervalued – are quickly spotted in the financial markets. Ironically, it is precisely those who invest actively who spot them.

Investment funds that track indices are among the most significant financial market innovations of the last 50 years. They are a blessing, particularly for savers, and even professionals use them for their own purposes. It seems that not even the recent criticism surrounding SpaceX will be able to halt their triumphant march.

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