The Evolution of Passive Investing in Stocks: A Brief History
When it comes to passive investing in stocks, indexes weighted by market capitalization have long been the dominant approach. This methodology finds its roots in “Modern Portfolio Theory,” which was developed by Harry Markowitz and William Sharpe in the 1950s and 1960s, respectively.
The industry standard for passive investing has been market cap-weighted indexes ever since John Bogle introduced the first index fund back in 1975. Not only has this approach been widely accepted within academia, but it has also proven to be practical in the real world.
It wasn’t until 1992 that Eugene Fama and Kenneth French expanded on the traditional market cap-weighted approach with their three-factor model. This model provided a more empirical explanation of stock returns and built upon the existing Capital Asset Pricing Model (CAPM).
In addition to the well-known beta, Fama and French introduced two additional systematic risk factors: small-market caps and low price-to-book ratios. These factors were found to have a significant impact on stock returns and were thus incorporated into the three-factor model.
The introduction of Fama and French’s three-factor model marked a significant shift in the passive investing landscape. It provided investors with a more comprehensive and nuanced understanding of market dynamics, allowing for better risk management and potentially higher returns.
Since then, various other factors and models have been developed and incorporated into passive investing strategies. This includes smart beta strategies, which seek to capture specific factors or traits that have historically been associated with higher risk-adjusted returns.
In conclusion, passive investing in stocks has come a long way since the introduction of market cap-weighted indexes. From the foundational work of Markowitz and Sharpe to the advancements made by Fama and French, the field continues to evolve and provide investors with new tools and strategies to navigate the market.
Analyst comment
Neutral news. The evolution of passive investing in stocks has resulted in the development of new models and strategies that provide investors with better risk management and potentially higher returns. This evolution is expected to continue, offering investors new tools and strategies to navigate the market.
