Do Current Market Conditions Pose Additional Risks for Passive Investors?

While Baldwin & Clarke Advisory Services, Inc. (“BCASI”) makes use of S&P 500 based ETF index funds to a limited degree in some client portfolios, we remain wary of certain embedded risks in market based investing, the most obvious being the lack of downside protection. Another is that the performance of the most popular indices is disproportionately driven by the largest companies, as measured by market capitalization. So called “cap weighted” indices.

A manager that we have a lot of respect for and one with a strong performance history is Polen Capital Management. Polen Capital recently issued a white paper which is very timely given the current debates about “active” versus “passive” investing. This white paper entitled “Credit Quality and Valuation Trends of the S&P 500 – A Critique of Passive Investing” is not an argument against passive investing, but rather an excellent analysis of how “…index investing has likely exacerbated market risk and left passive investors as the most vulnerable participants”. It is interesting and well worth reading, especially if you have a significant interest in an S&P 500 index fund or ETF.

Executive Summary:

Passive investing in U.S. equities has attracted billions in capital over the past several years as investors have been enticed by its low fees, efficient structure and seemingly endless product choices. But investor fervor does not necessarily equate to a quality investment. In fact, it appears the U.S. large cap equity market, as measured by the S&P 500 Ex-financials Index, has seen a deterioration in its fundamentals and credit quality over the past several years, yet its valuation sits at levels much higher than prior to the last recession. Investors may be unaware of the dangers that are presently embedded within the market and passive investment vehicles that, by definition, will be unable to pivot investors away from these risks. Active managers that focus on quality provide investors the ability to potentially mitigate some of these threats to their capital.”

We encourage you to read the entire article here, which is offered with Polen’s permission.

This article is not intended to provide legal or tax advice. Consultation with the appropriate professionals is recommended. Every transaction is unique and warrants individualized evaluation.



Charles H. Baldwin, MBA, CLU, ChFC

Co-founder and President

Baldwin & Clarke Advisory Services, Inc.


About the author: Chuck is the co-founder and principal of The Baldwin & Clarke Companies and the President of Baldwin & Clarke Advisory Services, Inc. Chuck specializes working with entrepreneurs, individuals, and their families to deliver high touch planning solutions designed to create, preserve and transfer wealth.