In a recent working paper, University of Toronto assistant professor Adriana Robertson takes a deep dive into the world of index investing and argues that it’s not passive in reality, but rather a form of delegated management.

In the paper, Robertson examined hundreds of indices and found that none of them were truly passive. “I think we have this idea in the back of our minds that indices are passive, in the sense that they’re divorced from human decision-making, they’re somehow objective in a way that other types of decisions aren’t,” says Robertson. “And so, what the paper really tries to do is shine a light on how indices operate and what the landscape of indices looks like.”

There is a lot of diversity among indices, so even those with similar aims have variety and represent deliberate decisions by managers, the paper said. “What I’ve found in doing my research is indices seem to exist almost along a spectrum, although it’s not really a linear spectrum, but you could certainly say that there are some that are more actively managed than others,” says Robertson.

In studying various index methodologies, Robertson found they’ve changed over time. “To take just one example, the methodology for the S&P 500 changed at least eight times between January 1, 2015 and April 30, 2018, and overall, the methodologies of this family of indices changed 22 times within that period,” the paper said.

It is important for investors who are comparing their managed portfolio to an index to understand that they are in fact comparing it to another managed portfolio, the paper said. “When an index is used as a benchmark, it is essentially being used as baseline against which the performance of some other investment portfolio can be compared. Logically, of course, any comparison between an investment and a benchmark is as much about the benchmark as it is about the investment in question,” the paper said.

Investors should rethink the use of indices as benchmarks, the paper recommends, although it doesn’t propose an alternative solution. “I don’t know that I have a perfect answer, but I think that it’s worth thinking about why it is that we use these benchmarks here when in almost every other market we use a very different approach to look at how good your product is,” says Robertson.

For those looking to purchase an index fund it’s important to understand that someone is still making active decisions, the paper said. “Here, the buying and selling decisions are taken out of the hands of the managers. Instead of the fund manager, these decisions simply being made by the index providers. Somebody is still making the decisions, and delegated management is still occurring,” it noted.

The research suggests this perspective could have implications for investor protections. “While a mutual fund cannot deviate from its fundamental policies, as stated in its registration statement, without a shareholder vote, there is no restriction on an index’s ability to change its methodology. This asymmetry leaves investors in “index” funds with fewer protections, and potentially facing higher risks, than investors in actively managed mutual funds,” the paper said.

As a solution to this problem, Robertson proposes similar requirements for indexes as for actively managed funds. For example, if a fund manager makes a comparable change in an actively managed fund that would have triggered a vote, the fund manager should have to do the same on retaining the index. “This simple change would harmonize the protections offered to investors in the two types of funds,” the paper said. Another protection could be additional disclosure, it added.

“One of the big takeaways of the paper at a high level is that indices, like so much else in finance and asset management, are really the result of decisions made by people,” says Robertson. “And of course, there’s nothing inherently wrong with that, but it’s something that I think we should be aware of and think about.”

Robertson’s paper is currently a working copy and has been accepted for publication in the Yale Journal on Regulation.