A Money Flow That Makes Sense

Despite the hype of the actively managed fund mutual fund machine it seems that the advantages of indexing are reaching more and more investors. From the WSJ:

Active vs. Passive: Indexing Wins '08
Benchmarked Mutual Funds Pick Up Share• By SAM MAMUDI
Mutual-fund investors in 2008 yanked more money out of actively managed stock-funds than they put in for only the third time ever, and index-fund rivals took some of the spoils.
The switch reflects a budding sentiment among many investors -- especially after a devastating 12 months -- that active fund management isn't always worth its higher fees. Index funds track a market benchmark and so provide average performance, typically at a much lower cost than actively run counterparts that try to beat the market on the upside and cushion blows on the downside.
Most managers fail to outperform their benchmark in a given year, however, and this bear market is no exception. Average losses for stock-index funds last year were 39.1%, while actively managed funds lost 40.5% on average, according to investment researcher Morningstar Inc.

(Don't ask me however why the Morningstar folk never just come out and tell people they would be better off ignoring all their "ratings" of active funds rather than sifting through their endless material evaluating and rating actively managed mututal funds).....

As well as the lower returns, Mr. Burns said that investors in actively run funds are more likely to chase performance and less likely to be focused on asset allocation. As such, they are quicker to dispose of their holdings.

Index-fund investors, meanwhile, more often use those funds as part of an asset-allocation strategy that see them through tough times in the markets, Mr. Burns said

....

Nonetheless hope springs eternal fuelled by the active mutual fund marketing machine and aided by fund "analysts" and personal finance magazines.

Index funds' share of the marketplace rose by 1.4 percentage points in 2008 to 13.2% from 11.8% a year earlier. Total assets in index funds at year's end were $490 billion; actively managed stock funds held $3.2 trillion, according to Lipper.
The change in market share doesn't include one growing player in the stock-fund world: exchange-traded funds, which mostly are indexed portfolios that trade on an exchange like stocks.

The biggest revolution in index (or passive or asset class) investing is the growth of the exchange traded fund (etfs) market. While there are doubtless too many etfs and many that are totally inappropriate such as leveraged and inverse etfs the proper use of these instruments allows investors to construct low cost transparent portfolios. While institutional investors and financial advisors are not the source of all investment wisdom, in this case I think they have been ahead of the curve (especially since I have been in this group :-):

ETFs are enormously popular with institutional investors and financial advisers, and lately with individual investors as well. Total assets in stock ETFs grew from $15.6 billion at the end of 1998 to $473.9 billion at the end of 2008, according to the Investment Company Institute. When ETF assets are included in index funds' market share, the total slice of the pie grows to 21.4%, and the challenge from indexed investment strategies to actively managed funds becomes even clearer.
"ETFs offer a broad range of indexes for investors," said Tom Roseen, senior analyst at Lipper. "Investors now have access to indexed strategies that didn't exist with mutual funds."
Other years in which stock funds saw net outflows were 1998 and 2002. And while investors subsequently returned, actively managed stock funds surrendered market share to index funds each time.