The changing of the guard in asset management is complete.

Passive overtook active in 2019: Assets in U.S. index funds and exchange-traded funds surpassed those in actively managed funds. 

But don’t shed a tear for active management just yet. There’s still plenty of money in vehicles overseen by security-picking managers. And, for that matter, many of the funds classified as “passive” follow indexes that show signs of a human touch.

Start from the top. The king of all ETFs, the $313 billion SPDR S&P 500 ETF Trust, tracks the S&P 500 index. That’s obviously a passive investment, right?

Check out the index’s methodology, and you might have second thoughts. Sure, there are rules for index composition, but ­membership is also subject to the “discretion of the Index Committee.”

Committee? Discretion? That doesn’t sound too different than an investment manager that has to operate within a set of mandates. And it contrasts with the methodologies of peer benchmarks. “Most other major indexes have a strict, rules-based approach and structured rebalance schedules,” according to a commentary from Vanguard Group titled ­“Decoding the poetry of the S&P 500,” published on the asset manager’s website in November.

Think discretion is only applied at the margins? Not so fast. Consider how David Blitzer, former index committee chairman of the S&P Dow Jones Indices, described the decision to keep insurance behemoth American International Group Inc. in the index after its collapse in 2008. If the committee had followed the rules, AIG should have been removed. The U.S. Department of the Treasury owned 90% of the company, and the S&P 500 guidelines state that a company is required to maintain a public float of at least 50%.

“In those scary moments, dropping AIG would have sent the markets tumbling yet again,” Blitzer wrote in a blog post titled “Inside the S&P 500: An Active Committee,” published on the S&P’s Indexology blog on Aug. 7, 2014. “Given market conditions and investor fears, the index committee quietly set the 50% float rule aside.”

The Invesco Aerospace & Defense portfolio ETF tracks the Spade Defense Index. Again, it sounds like a passive fund, but the Spade index doesn’t fly on autopilot. 

Scott Sacknoff, president of Maryland-based Spade Indexes LLC, says maintaining an element of discretion comes down to the difference between a benchmark and an index. “A benchmark requires an actual understanding of the sector or theme, while an index is just a collection of random firms,” he says. Spade is in the business of developing benchmarks.

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