Don’t Be a Passive Index Fund Investor
I am not a power user of Linked In, but once or twice a month I sign in to see what’s happening. I typically find interesting posts from Alex Matturri, retired CEO of S&P Dow Jones Indices and the person who promoted me to Head of Index Governance during my former life at S&P DJI. Alex recently shared his thoughts on a great article by Craig Coben, published in Financial Times on February 26th.
I recommend Mr. Coben’s piece, “Nasdaq wants to fast-track founders and let index trackers hold the bag: Engineered scarcity, meet dumb money”. His analysis of a change to the Nasdaq 100 index rules provides a window into how the modern index ecosystem operates. There may be legitimate analytical reasons for believing inclusion of significant IPO’s in market indexes should occur in a timely fashion. However, there are also unspoken commercial motivations that affect index design and may be cloaked in seemingly reasonable arguments for index rule changes. As Jason Zweig observed in his March 13th Wall Street Journal column[1] on the topic of the very same Nasdaq index consultation, “… putting giant IPOs into indexes at five times their stock market representation … feels arbitrary, unfair and potentially risky for the people who should matter the most: investors.”
On March 30th, Nasdaq announced the conclusion of its index consultation, which included six proposals for NDX rule changes. Proposal 3, “Inclusion and Weighting of Securities with Low Float”, was to adjust the index weight of each “low-float” security (those with less than 20% free float) by a factor of 5. This was the specific proposal Jason Zweig referred to in his column. Nasdaq clearly received mixed feedback about this proposal, and it settled on an adjustment factor of 3 rather than 5. In the “Summary of Responses and Conclusion”, Nasdaq stated, “Some respondents, in their analysis of the impact, appeared to assume that the index is currently free-float-weighted; however, this does not reflect the current methodology.” I don’t know about the consultation respondents referred to here by Nasdaq, but Mr. Coben made no such assumption in his commentary. In fact, he specifically noted, “Today (under current rules), companies are included at full market capitalization if at least 10 percent of shares are publicly traded” and he went on to explain how mega-cap companies seek to game the proposed index rules by effectively substituting size for float.
Whether NDX administrators use a factor of 3 or 5, it is clearly an arbitrary rule which, in combination with the drop of the 10% free-float requirement, is designed to facilitate fast track index entry of huge IPO’s with low float. Some of the commercial pressure to include such companies may come from index fund asset managers who want headline names in the benchmarks they track. Some of the commercial pressure comes from bankers and insiders who want price support for their new listings. And Nasdaq obviously wants these listings. In other words, there is an unacknowledged alignment of underlying commercial interests that do not enter public debate. I suspect that is why the entire public discussion begs the question: In combination with a new fast track rule, why not consider a simple, intuitive change like weighting all constituents by unadjusted free float market cap like other popular indexes? Such a change would apply even-handedly to all index candidates and constituents.
I do not believe it is a coincidence that SpaceX filed for its IPO later in the same week, just a couple of days after Nasdaq’s announcement of NDX rule changes on Monday the 30th. SpaceX bankers and insiders now know for sure that there will be not just robust, but outsized, demand for the shares coming from NDX trackers 15 trading days after the IPO.
Ben Graham famously contrasted a prototypical “enterprising” investor with a “defensive” one. In the introduction to the 1973 revision of his magnum opus, The Intelligent Investor, he associates defensiveness with passivity, “The defensive (or passive) investor will place his chief emphasis on the avoidance of serious mistakes or losses. His second aim will be freedom from effort, annoyance, and the need for making frequent decisions.”[2]
As brilliant as he was, Mr. Graham may not have imagined how the development of the first index fund, created by Jack Bogle only a few years later, would transform the investment opportunity set. Modern investors can expect to earn the equity premium while avoiding mistakes (in selection of securities or managers) by simply investing in a low-cost, cap-weighted, total market index fund.
Perhaps Mr. Graham’s association of defensiveness with passivity led to the modern financial jargon, where index investing is referred to as “passive”. But contemporary indexing has grown and morphed into something very different than straightforward modelling of the stock market. I know from direct experience that business leaders, investment bankers, asset managers, hedge funds, and other informed market participants allocate significant time and resources into understanding index rules, anticipating and positioning around index trades, and sometimes seeking index methodology changes like those proposed in the NDX consultation. These market participants do not invest time and money without expecting a positive return on that investment. They may not be enterprising in the way Mr. Graham described. The last thing they typically care about is intrinsic value. However, in a contemporary sense, they are highly enterprising.
These informed market participants are frequently on the other side of your index fund’s trades. Therefore, you, the index fund investor, need to invest time and resources into understanding index rules. You need to be (at least somewhat) enterprising. Your aim should be to have sufficient knowledge to avoid being “dumb money”.
As an index fund investor, you should seek not merely to avoid mistakes of individual security or manager selection. As an informed index fund investor, you should seek to avoid mistakes of poor index selection. This means avoiding investment in an index product where the underlying index is likely to serve as a conduit for capital flows from uninformed money to informed money. Here are a few of my observations and suggestions…
1. If you want to earn the equity market premium, invest in a low-cost total market (float-adjusted market cap weighted) index fund.
2. If you are going to invest in other types of index products, the narrower or more complex the index the more enterprising you need to be. Modern index design is highly intertwined with financial product design. In many cases, indexes are designed to facilitate active risk so that product trackers can claim to be passive while, at the same time, offering “outperformance”. Huh? Talk about turning a simple concept inside out!
3. Narrow and/or complex indexes with a lot of AUM growth can be a time bomb, often triggering index consultations to change rules and leaving investors holding an index basket that is fundamentally different than the one they bought into.
4. Indexes administered by stock exchanges typically have a baked-in conflict. They usually only include securities listed on the sponsor’s trading venue. NDX is the most prominent member of this set but is joined by many others globally. For a stock exchange, sponsoring a popular index is a great tool to attract listings.
When Mr. Bogle developed the index fund, he probably did more for the good of individual investors than anyone before or since. But money attracts opportunists of all stripes. Modern index investors can no longer afford to be passive.
© 2026 Philip Murphy. All rights reserved. The information presented is the opinion of the author and does not reflect the views of any other person or entity unless specified. The information provided is believed to be reliable and obtained from reliable sources, but no liability is accepted for inaccuracies. The information provided is for informational purposes and should not be construed as advice. Advisory services are only offered through IndiePlan™ LLC, an investment adviser registered with the state of New York.
[1] Jason Zweig, “Should Hot IPOs Get Special Treatment?”, March 13, 2026; The Wall Street Journal.
[2] Graham, Benjamin. The Intelligent Investor, Revised Edition, 1973; with updated commentary by Jason Zweig. HarperCollins, 2003.