No country for retail investors: Are your ETFs a great product – or are you the product?

Atul Tiwari is the chief executive of Verdx. He was the founding president of BMO ETFs and the inaugural chief executive officer of Vanguard Canada. The two firms now account for approximately 36 per cent of the Canadian ETF market.

I was sitting in the investing giant John Bogle’s Vanguard office in Malvern, Penn., in 2012, and I was nervous. I was defending my last 11 years of work.

At the time, I was helping build the ETF industry in Canada and found myself discussing one of the industry’s earliest and most successful products, the bread and butter of do-it-yourself investing: the S&P 500 ETF.

I was confident in my work. But Vanguard founder Mr. Bogle was a legend, after all, and possessed a rapier wit that he never hesitated to unleash. And he did not like ETFs.

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Mr. Bogle’s office was stacked with books, photos of himself with presidents and other luminaries, and he peered at me across piles of notes he was making for another of his numerous academic papers. He hollered to his assistant outside his office to bring in his latest research on the trading of ETFs as he was “going to have a debate with Mr. Tiwari.”

I remember saying: “Mr. Bogle, I understand your concerns about ETFs, but aren’t they a good way to put investing into the hands of more retail investors?”

His response has stayed with me ever since. “The reality is that I am in favour of indexing.” Mr. Bogle had popularized the concept behind ETFs, of passively tracking a broad market. Aug. 31 was the 50th anniversary of his first retail index fund. But Mr. Bogle had been doing index tracking with mutual funds, whose units do not trade on stock exchanges.

“The problem,” Mr. Bogle said, “is that the ETF vehicle makes it too easy to trade the index rapidly, in real time, on an exchange. Unlike mutual funds, which settle at the end of the day, ETFs create temptation. They tempt investors to time the market. That is my worry.”

At the time, I respectfully disagreed.

Today, I think his warning was more profound than I appreciated. Mr. Bogle understood that an investment idea and the vehicle used to deliver it are not necessarily the same thing. A product designed to facilitate patient, diversified ownership (good for retail investors) could also encourage frequent trading and active decision making (not so good for retail investors).

The same distinction now applies to retail investing more broadly.

ETFs democratized investing. State Street, an asset manager, describes retail investors as the “primary force” behind ETFs’ boom. In the United States, the number of households holding at least one ETF reached nearly 17 million by 2024, up from less than one million in 2005. In Canada, do-it-yourself investors now hold a greater share of ETF assets than investment advisers. ETFs have allowed more people to build their savings and ride the bull market of the past 30 years.

But then the market changed.

ETFs no longer just tracked an index. Active ETFs proliferated. Some ETFs go as far as replicating certain politicians’ trades. And SpaceX’s recent stock market debut, the latest mega-public-offering, represents a new era where companies stay private for years or shun public investment altogether. In more ways than one, the index no longer reflects the whole market. Then when companies that grow big while staying private do go public, it’s questionable how much growth is left for everyday investors to capture.

Looking back, I wonder: Whatever happened to the original promise of the ETF, to provide simple passive index tracking to retail investors?

For decades, investors were told there were two competing philosophies: active investing and passive investing. One side believed skilled managers could identify winning companies and outperform the market. The other believed trying to beat the market was largely a fool’s errand and that investors were better off simply buying the market itself. As Mr. Bogle famously said: “Don’t look for the needle in the haystack! Just buy the haystack!”

The battle is over. Based on decades of fund flows, passive investing won. The investor Warren Buffett famously won a million-dollar bet against a hedge fund-of-funds manager who could not beat a simple S&P 500 index over a 10-year period. And even if professionals can beat the market, it’s probably not worth it for the everyday investor to try. That’s the simple premise that lay behind retail investors’ embrace of ETFs.

One of the asset allocation ETFs that I sketched out with The Globe and Mail’s now-retired personal finance writer Rob Carrick in an Ottawa café in 2017 and later launched at Vanguard remains, in my view, one of the best core investment solutions available to Canadian investors.

Low-cost, broadly diversified index funds remain difficult to beat as the foundation of a long-term investment portfolio.

But is the battle between active and passive investing really over?

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The genius of indexing was its simplicity. Investors no longer needed to decide which companies would win. They simply owned the market. Investment costs went down. Transparency improved. Millions of investors benefited. It was one of the greatest democratizations in financial history.

But something curious happened on the way to victory. The ETF, which contributed to the rise of passive investing, made portfolios easier to trade actively. The proliferation of sector, thematic, factor and other specialized indexes made it easier for investors to express increasingly narrow views, making extremely specific investments, while still describing themselves as passive.

The choices are endless. Don’t fancy tracking the trades of U.S. politicians? How about an inverse ETF that aggressively shorts bitcoin, going up three times the value of any decline in the cryptocurrency? Or perhaps an ETF that invests in single stocks? Yes, that is right. A stock that invests in one stock. Much like with the inverse bitcoin ETF, such products might move several times the movement of the underlying stock or in an opposite direction. Morningstar reported on Aug. 21 that the median single-stock ETF has lost 38 per cent while having paid over $500-million in management fees over the four-year period ended July, 2026. Indeed, fees for such active funds are another issue, and can rival those of mutual funds, partially defeating the original purpose of ETFs.

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Mr. Bogle’s concern about investor behaviour proved prescient. An investor who continually moves among technology, artificial intelligence, clean energy, cryptocurrency or other thematic ETFs is using passive vehicles to make active market calls. The securities inside each fund may be selected according to an index, but the investor is still choosing sectors, themes and entry points and often attempting to time them. There are now more ETFs than listed stocks.

The ETF wrapper may be passive. The behaviour may not be.

And most importantly, consider that while ordinary investors watched from the sidelines, venture capital firms, private equity funds, institutional investors and insiders participated in SpaceX’s SPCX-Q rise from a startup to a company valued close to US$2-trillion.

By the time companies such as SpaceX – and coming soon, OpenAI and Anthropic – eventually become available to broad public market investors, a significant portion of the value creation may already have accrued to private investors.

Millions of retail index investors, pension funds that invest on their behalf, RRSP holders, TFSA investors and ETF investors are forced to become buyers at the price offered to the public since index funds must track the entire market, but they are coming late to the party. This can be seen by the disappointing performance of SpaceX since its debut. The company now trades at about US$135 a share, way down from its peak of US$225 reached just days after launching.

The original promise of indexing was simple: own the market and participate in broad economic growth. Now retail investors may simply be providing liquidity to earlier investors who participated in the most explosive stages of growth. That should matter to anyone saving for retirement.

The issue with SpaceX reflects a wider issue: Public markets no longer represent the economy in the way they once did.

According to Northleaf Capital Partners, the number of publicly traded companies in the United States has declined dramatically over the past two decades, to 4,300 from approximately 7,000. At the same time, vast pools of venture capital, private equity and private credit have enabled companies to remain private for much longer.

Investors are still buying “the market.” The problem is that the market increasingly represents only a small part of the overall opportunity set.

Even within public markets, indexing is not quite as passive as many investors imagine. There are now millions of indexes globally. The S&P 500 itself is not simply the 500 largest companies in America. Inclusion is determined by a committee of humans that exercises judgment regarding eligibility, profitability, sector representation, corporate structure and other factors.

Nasdaq recently amended its rules to accelerate the inclusion of certain newly public companies such as SpaceX and reduce some eligibility requirements. Some market participants viewed those changes as increasing Nasdaq’s attractiveness to current and future mega-IPOs. Whether one agrees with those changes or not, they highlight a larger shift taking place in capital markets.

Consider that S&P chose not to make similar changes as Nasdaq. The result is that investors may now need to make an active decision on whether to bet with AI/space colonization, or against it, depending on the index they select.

None of this is inherently wrong. But it is not the purely mechanical, rules-based world many investors imagine when they think of indexing.

Then there is concentration.

Today, a small number of mega-cap technology companies drive an outsized share of market returns. The 10 largest stocks in the S&P 500 accounted for more than 40 per cent of the index’s value in May.

Many investors in ETFs believe they own broad diversification. In reality, they are making increasingly concentrated bets on a handful of companies.

The irony is difficult to ignore. Passive investing won because investors stopped trusting experts to pick stocks and wanted diversification. Yet today’s markets increasingly rely on experts to define indexes, determine eligibility, revise methodologies and decide what belongs in the benchmark.

Passive investing won. Then it quietly became active.

John “Jack” Bogle had grown up during the Great Depression, in a wealthy family that lost it all. Mr. Bogle’s First Index Investment Trust – the first index mutual fund available to the retail public – was not popular at its creation in 1976. (In fact it was derided as “Bogle’s folly,” but has been lauded by the likes of the investment guru Mr. Buffett ever since.)

It was a different time, before AI, cryptocurrency and even the dot-com bubble, before online do-it-yourself platforms. Proportionately, fewer large companies were private. Investors now should recognize that the world Mr. Bogle built indexing for has changed.

Direct indexing, where investors can choose their own basket of stocks from an index, is growing. Private market access is expanding. AI, information markets and other innovations are challenging traditional assumptions about investing. We are no doubt entering another period of innovation in financial products and market structure.

Mr. Bogle’s concern was that investors could use an index product in ways that undermined the discipline of indexing. The challenge today is broader.

Mr. Bogle changed investing forever by asking a simple question: Why try to beat the market when you can own it?

The next generation of investors may need to ask a different question: If the most valuable companies stay private longer, and public investors arrive only after much of the growth has already occurred, what exactly is the market anymore?

The answer is becoming less obvious.

And that may be the most important investment debate of the next decade.