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Index Funds May Work a Little Too Well

307 points by chollida1 11y ago

howeyc 11y ago
Interesting. The idea is that index funds implicitly favor collusion between companies in the same industry since investors/institutions own the competing companies (perhaps even at the same weight). That is, an index owning both Coke and Pepsi may not be too keen on one slaying the other, but instead for them both to become bigger together, yet separate. There's also the idea that index investing "should" be considered illegal because of the possible antitrust issues. Also, the rise of index investing puts more favor to stock buybacks/dividends as opposed to reinvestment. The idea being (as an example) that the index would rather take Coke's profits and redirect to a smaller higher-growth-potential company (or even spread it out more evenly among all holdings). However, if no index investing, perhaps investors would be more willing to "ride it out" with Coke reinvesting a lot more profits back into the business (maybe the don't own Pepsi, or other soft-drink companies and want to see them all get demolished).
- paganel 11y ago
  In other words, there's no "silver bullet", no matter the industry. I also think that we should stop believing in the "wonder" of compound interest and act accordingly, because it will come a time when this "wonder" will prove to be just that: a thing that cannot last forever. The same goes for a guaranteed rate of return on investment.
  - maaku 11y ago
    where did you pull that from?
    - paganel 11y ago
      As far as I've read "index tracking" is seen as this wonderful thing that cannot go wrong. Until it does. It's another way of saying "this time is different". The last part of my comment is related to the fact that "index tracking" and all the related "investment strategies" rely on the assumption that, over all, things will only go up, i.e. ROI will always be positive. I questioned that assumption. We cannot guarantee that in 30 years' time (let's say) we will still be able to return 3-5% on our huge piles of pension funds' money, no matter the strategy. What I'm saying is that we should be prepared for a stagnating or even deflationary world, financially and economically speaking
      - kspaans 11y ago
        It's almost entirely about paying less in fund fees and aiming to be 'average'. I.E. get the return of the market rather than trying to beat it. Think of it as 'passive' investing rather than index investing. EDIT: But yes, we don't know whether one can assume "The S&P500 will average 10% per year for EVARRRRR!!!1".
        gburt 11y ago
        I'm not the OP or the grandparent post, but I wonder what happens if a significant portion of the market starts indexing? My gut is that there are strong incentives against that: as more people start indexing, the gains from not indexing become more diverse.
        debacle 11y ago
        On the same token, more indexing will insulate losses by creating an implicit demand based on market cap.
      - mcguire 11y ago
        You realize that the scenario you describe is equivalent to "the entire collapse of global civilization that will make previous dark ages look like candy and unicorns." I'm serious. If the overall economy is "stagnating or even deflationary" for any significant period of time, all of the wheels are going to come off. (Really want a dark thought? You realize that we've dug up and used all of the easily-available oil, right? When Some Later Generation Gets Its Act Together, they aren't going to have a convenient, cheap source of energy.)
        JoeAltmaier 11y ago
        Information can no longer die - CDs, DVDs, libraries - a new dark age will be mercifully short. And as for cheap energy - there are plenty more, better sources than oil.
        11y ago
  - ryangittins 11y ago
    What are you talking about? No one believes in the "wonder" of compound interest. They believe in the mathematics.
    - damoncali 11y ago
      I think the point the parent is getting at is that nothing about business guarantees constant, compounding growth. It's not just mathematics, it's population growth, productivity, capital distribution, etc. - lots of stuff that we take for granted that results in constant growth rates, but that doesn't necessarily have to.
      - im3w1l 11y ago
        Compounding interest could continue at the upper right part of the S-surve. If the interest decreases every year, and sufficiently fast, it could give rise to a convergent infinite product. So total wealth would never exceed the threshold of the possible.
    - crimsonalucard 11y ago
      While physical laws do not bound mathematics, they bound the reality and context in which we talk about "compounding interest."
  - nemo44x 11y ago
    Compound interest accumulation, over a long enough period of time has historically ended in blood & ashes and redistribution.
    - Lawtonfogle 11y ago
      Capital could never be directly translated into power. Capital always had to be used to buy enough people who combined had power. Those people could refuse to be bought and instead join those without capital on moral reasons. Even as technology allowed us to use capital to increase the power of a small group of people, there still had to be a small group of people. But we are soon to hit a point where capital will be used to buy power directly thanks to advances in AI and robotics. We may never again have another cycle like you describe.
      - marcosdumay 11y ago
        To be honest, I fear this, because I consider it likely enough to fear, but I don't think it's the most likely outcome by a big margin. If you want to know the probable outcome of an Intelligent Capital vs. The People fight, just look how a big company defends its computer network against targeted hackers today.
  - brc 11y ago
    Seriously. Sometimes I wonder about who actually is visiting this site. The 'wonder' of compounding interest? It's merely the monetary representation of the return on investment in productive activities and assets. The reason money has a cost is because it can be converted into useful, productive activities, so the holder needs to be compensated for that. The 'wonder' is how animal herds and horticulural products increase enough in quantity to feed us all. Building a shelter over your head is compounding interest at work. You sleep better, stay healthier and have more time to do other things. Same goes for a knife or a spear, or a factory or a computer. I find it incredibly odd that we have people running around saying 'we have to stop growth' 'growth is bad'. Yet, on all measurable criteria - every single one of them - things keep getting better. This is because of the compouding effect of investment in knowledge and productive capacity. I'm not sure where the growth-hate comes from, if it is ignorance or just some sort of strange moral fashion to hate on the modern world. Either way, a class of people have convinced themselves that - of the entire trajectory of growth from nomadic paleoithic peoples to now - it's right at this point the wheels are about to fall off. Strikes me as a little narcissistic, really.
    - paganel 11y ago
      > Seriously. Sometimes I wonder about who actually is visiting this site. I'm a programmer who sometimes reads about economics and economics history. I've also worked in some finance-related industry for a couple of years early in my career (in the IT department). > This is because of the compouding effect of investment in knowledge and productive capacity. Yes, I know how compound interest presently works, I was just questioning its long-term (think 50-to-100 years, if not more) viability. To give an example which I stole from people smarter than me, just think that if you had invested your pension money on the Russian stock market in the 1910s or on the Chinese stock market in the 1930s you would most probably be bust (to say nothing of nationalizations and confiscations of private real estate). And these are two pretty big examples which happened in the last 100 years. The idea that the return on the rate on investment on the long term can only go down I've stolen from Jean-Baptiste Say, who wrote it down in the ~1820s. Now, he just happened to write this before the Industrial Revolution started doing its thing and, just as important, before economic colonialism started to positively influence the Western economies of that time (think the Opium Wars). Now, you're saying that we'll be able to somehow reproduce that Industrial Revolution a second time, I question that optimism. > I'm not sure where the growth-hate comes from I'm not at all "hating growth" (even though I believe that we should be well aware of its downsides). I'm just saying that it's no good making only positive economic projections about the future, we're not magicians and crystal balls are just that, pieces of glass.
- aetherson 11y ago
  An index owning both Coke and Pepsi wants the soft-drink market to grow bigger -- it is presumably indifferent to whether Coke slays Pepsi, Pepsi slays Coke, or both grow bigger together, as long as the total market increases. Which is arguably a good thing. Let's say that Coke has 60% of the market and Pepsi has 40% of the market. If Coke's investors are separate from Pepsi's investors, then it would be in their interests to take a tactic that kills Pepsi and allocates half of its market share to Coke and the other half goes up in smoke to a smaller overall market -- now Coke is half again as big as it was! But the industry is smaller. That said, I'm not sure that realistically, market-decreasing tactics really exist in most cases -- I can't think of a real world example. The collusion argument is certainly interesting.
  - makomk 11y ago
    More precisely, an index fund owning both Coke and Pepsi wants profits from the soft-drink market to grow bigger, and the easiest way for that to happen is for both companies to increase their prices at the same time. Note that this is exactly the opposite of how competition in capitalism is meant to work - it's meant to drive down prices towards the cost of production, increasing overall efficiency as it does. Note also that this likely also results in selling less soft drinks than if the companies were actually competing, because increasing prices generally decreases sales.
    - fweespeech 11y ago
      I'm not sure that is an actual problem. Generally, executives get compensated in stock in some way in their company. So the Coke C-Suite is motivated to compete with the Pepsi C-Suite even if the board members are the same for both companies.
      - eitally 11y ago
        I think it is a problem. Unless you've worked in one of these industries where there are a handful of major players and rough parity of capability between them (like consumables, electronics manufacturing, heavy industry, oil & gas), corporations trade execs on a regular basis, and when those execs jump ship for a competitor they often lure away a good number of their key staff, too. So not only do you end up with a bigger overall market if they all do well, you end up with leadership (both executive staff and board members) who knows the ins & outs of everyone. It is in everyone's best interest for everyone to succeed, but if a company falters significantly it becomes either an acquisition target or it slowly fades away as key talent migrate to competitors. Not only this, but if you attend the earnings calls for corporations in the same sector (or even better, if you're lucky enough to attend one of their investor & analyst days), you'll see firsthand how the analysts are wined & dined, and how closely everyone knows everybody else. It's a big game that creates a ton of wealth at the top -- as long as the status quo is roughly maintained and change is incremental.
- rhino369 11y ago
  Maybe the solution should be that index funds just shouldn't be able to vote their shares.
praptak 11y ago
Interesting. With enough optimisation of the mechanisms of modern capitalism we arrive at a state where a single amorphous entity owns the economy so there are no incentives created by competition.
- uptown 11y ago
  You could say the same for politics.
  - danharaj 11y ago
    That is true if you limit yourself to preserving some political structure. It is not true if you consider revolutions and radical changes to be politically legitimate. There is no ideology or system you can encode in prescriptive rules that endures forever. Capitalism(s) has had a long run, but so did feudalism(s). I pluralize because those systems have changed. What happened to feudalism in the end was that its fundamental tenets were overthrown. What remained could not be called feudalism. It remains to be seen if and how that occurs with capitalism. What can be discarded to make the incumbent institutions endure? How long will that last?
  - praptak 11y ago
    I don't think any political entity owns the economy. Quite the opposite - campaign funding is how the economy controls politics.
    - nickff 11y ago
      I have only seen recent studies finding that campaign spending has little impact on electoral outcomes; if you have evidence that elections can be bought, please provide it, so that I may be enlightened.[1] [1] http://pricetheory.uchicago.edu/levitt/Papers/LevittUsingRepeatChallengers1994.pdf http://pricetheory.uchicago.edu/levitt/Papers/LevittUsingRep...
      - praptak 11y ago
        "I have only seen recent studies finding that campaign spending has little impact on electoral outcomes;" It's a 1994 article and the research didn't stop in 1994. There are quite a few after-1994 articles supporting either view. "if you have evidence that elections can be bought" Influenced. Here's an example one from 2004: http://karlan.yale.edu/fieldexperiments/papers/00246.pdf http://karlan.yale.edu/fieldexperiments/papers/00246.pdf TLDR: authors designed and performed some actual experiments whose outcomes support the thesis that campaign spending works - better for a challenger than for an incumbent.
VLM 11y ago
The OSS model is instructive as an analogy. 80% and shrinking of the fund market is closed and proprietary software. Its very expensive and relies on single points of failure, often one person per fund. There's a lot of propagandizing that they're the only way to invest or best or whatever. 20% and growing of the fund market is free open source allocation, here is TODAYs definition of an index now buy stock to reflect it. Needless to say its incredibly cheap compared to the closed source funds and arguably gives an overall higher rate of return. Some of the lower rate of return of closed source funds is because of their massive advertising and propaganda budget spent to convince investors that they're a better deal. Sometimes, by obscure enough definitions of better deal, they are. Usually not. Needless to say someone who's paycheck depends on FUDing the free competition isn't going to have anything nice to say about FOSS or index funds. The idea that FOSS or an index fund is a conspiracy is kind of weird. If index funds are made illegal on that ground, I suppose Emacs will be made illegal soon because its unfair to make individual proprietary editor writers compete with the entire world teamed up against them. "The right of the rich to privatize gains and socialize losses shall not be infringed" and possibly other constitutional amendments will be marched out in the corporate press, etc.
- stdbrouw 11y ago
  The article is not about index funds competing with alternate investment opportunities and whether or not the competition is fair, it's about what index funds do to the competitiveness of the companies they invest in.
  - VLM 11y ago
    Exactly, that's the best way to present FUD. Don't tell people you're trying to grind an axe, just say I'm merely providing free advice from my grindstone financed workplace.
curiousjorge 11y ago
Index fund works well because it's diluted. When you invest in a single company there are many unknowns and downsides but stretched across the sector, you find less risk (how likely is it that other than Toshiba and Kodak are cooking books). However, the returns are also limited to the sector as well. I admit picking undervalued companies AND being solvent enough before the market reacts rationally is a huge undertaking and why there's so little of successful value investors.
obblekk 11y ago
This is cool, but incomplete. An index fund would still want competition if by competing, Pepsi gains 100% and Coke loses 1%. i.e., in any case where competition grows the pie rather than cuts it up differently, the index fund would want competition. I claim this is the right result. We should discourage competition where everyone ends off worse, and encourage competition otherwise. Individuals competing do things like dump goods below cost to bankrupt smaller competitors; an index would perhaps not do that.
- praptak 11y ago
  "Everyone ends off worse" - by a strange definition of everyone that leaves consumers out of the equation.
  - obblekk 11y ago
    Well, consumers shouldn't be much worse off, otherwise it creates an arbitrage opportunity. Although Pepsi and Coke may be indexed, they aren't the same entity allowing investors to just own one. If there's some action that Pepsi could take that would massively reallocate the pie in it's favor (by winning over consumer for instance), then investors ought to start massing to it and becoming more activist. This would come at the expense of the index of course. So really as long as there's easy 'severability' of the companies in the index, they shouldn't be overtly monopolistic. But I agree in industries with high capital requirements (energy, biotech, etc.) it may be impossible to separate out the companies and then they would be de facto merged. This really is an interesting idea because a solution seems hard to find. Outright banning indexing would be nearly impossible to enforce (large pension funds could reproduce the index at a slighter higher cost).
    - theseatoms 11y ago
      > Well, consumers shouldn't be much worse off, otherwise it creates an arbitrage opportunity. Only if the industry has a low barrier to entry.
  - davidw 11y ago
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cmsmith 11y ago
The article's focus on the temptation for collusion seems overblown to me. Yes, the interests of Pepsi+Coke's index shareholders are served if the companies avoid cannibalizing each other's value, but those shareholders have no way to apply pressure on the companies to do that. Index shareholders do not vote, and by their nature cannot sell shares of a company that they are displeased with. The other concern seems more well-placed. An efficient market requires that shareholders buy and sell companies in response to performance. Index funds buy and sell companies in response to the performance of the fund, or the market as a whole, or some other arbitrary factor. If 50% or 80% or 90% of a company is owned by 'dumb' funds, what does that do to their market value? And how could that affect the choices of the CEO?
- kspaans 11y ago
  Vanguard may invest passively, but they claim to do active things with their proxy votes: https://about.vanguard.com/vanguard-proxy-voting/ https://about.vanguard.com/vanguard-proxy-voting/
- gnopgnip 11y ago
  The index funds are rebalanced frequently. If an individual ticker is delisted(usually due to size or mergers) those stocks get sold.
deleted 11y ago
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bickfordb 11y ago
If index funds create larger voting blocks of shares, wouldn't that create a more powerful pool of voting power to influence changes than if all shareholders were voting individually? Index funds could turn over voting control to a proxy/research based voting service or survey their investors to determine how to vote. I'm embarrassed to admit I actually don't know the voting policies of the major index funds I'm invested in (VTI, AGG mostly).
- saryant 11y ago
  http://www.vanguard.com/pub/Pdf/sai040.pdf http://www.vanguard.com/pub/Pdf/sai040.pdf Page 45.
elipsey 11y ago
The quote "stock acquisitions that create such anticompetitive horizontal shareholdings are illegal under current antitrust law" doesn't seem to include any reference that I can find to any original text written by Elhauge. Instead the footnote links to a bunch of the author's own articles about Elhauge. The only properly cited textual evidence offered is a series of denials by Elhauge that he ever said index funds are illegal. Levine has been writing about this for months in articles with linkbait titles like: "Should Mutual Funds Be Illegal?" (http://www.bloombergview.com/articles/2015-04-16/should-mutual-funds-be-illegal- http://www.bloombergview.com/articles/2015-04-16/should-mutu...) and "Labor Department Wants to Tweak Your Retirement Plan" (http://www.bloombergview.com/articles/2015-04-15/labor-department-wants-to-tweak-your-retirement-plan http://www.bloombergview.com/articles/2015-04-15/labor-depar...) It seems like Levine has an axe to grind with regulators, and doesn't want anyone to talk about research that might suggest regulation. He might be right, but he is making a crappy argument. EDIT: Ok, I stand corrected. Elhauge totally said that. It's in the abstract. I had trouble finding it because Levine cited himself instead of the paper at the end of that that paragraph. Sorry.
- ikeboy 11y ago
  That's a direct quote from the linked paper http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2632024 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2632024
- anigbrowl 11y ago
  More likely he just mixed up his URLs with his anchor text. Linked from 'Elhauge claims to disagree with my interpretation': http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2632024 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2632024
paulpauper 11y ago
index allocation as a % of total assets will keep rising, but total assets will also keep rising.. That means individual stocks will still have price discovery despite a futuristic scenario where 99% of all money is indexed. The mechanism for how this leads to collusion is unclear.
sandworm101 11y ago
Why the assumption that an index must represent a market? Wikipedia def: "An index fund (also index tracker) is an investment fund ... that aims to replicate the movements of an index of a specific financial market, or a set of rules of ownership that are held constant, regardless of market conditions." The OP only discusses the former, not the later. I see the point that an indexed fund tied to a specific market, the narrower the better, may bring antitrust rules into play. But the later concept, that a indexed fund is simply a fund with fixed buy rules, need not get anywhere close to antitrust. They need not have a presence across any "market" as conceived by antitrust. How about an indexed fund with the rule: Own equal numbers of share from all publicly-traded social media firms, except facebook. Such an indexed fund might find lots of investors without getting anywhere close to antitrust.
- theseatoms 11y ago
  Sure, index funds can track any sort of index, and use any sort of weighting scheme. But modern portfolio theory dictates that truly passive investors should hold two assets: the "market portfolio", and a "risk-free" asset such as Treasury bonds, or cash. As other commenters have mentioned, "index investing" is better referred to as "passive investing".
  - sandworm101 11y ago
    I think the very term "indexed fund" is an artifact. Indexed funds need not be tied to an index. They can still be "passive investing" without the index. "Antitrust" is a similar linguistic artifact as you can violate antitrust rules without any mention of trusts,
    - theseatoms 11y ago
      I agree we should get away from the term "index fund", but for better or worse, investors are hung up on indices. Why do we talk about the S&P 500? Why not 1k? etc. Don't get me started on the price-weighted Dow...
dataker 11y ago
I just can't see it as something positive. This is signaling that monopolies have massive power in their industry horizontals. 'To compete', they must take over another industry horizontal.
bcg1 11y ago
A bigger problem with index funds is the inherent bias they create towards consolidation of capital at the top. A company that becomes part of the S&P 500 will automatically have bi-weekly buyers of their shares as people pump money into index funds via payroll deduction. Nearly every piece of mainstream financial advice in the US suggests such behavior... "d% of mutual funds fail outperform the S&P 500" etc. Of course such comparison ignores transaction costs, administrative costs, risk, diversification across asset classes, et al. However, it leads to many people who want to "Set it and forget it" to just buy the S&P 500 index companies automatically every 2 weeks, pumping up the values of large cap corporations whether they perform well or not. I know that companies don't necessarily benefit directly from an increasing stock price, but in reality it allows them to raise capital by issuing new shares with less dilution. Also it makes it costlier for smaller competitors to raise capital, crowding out competition. At the end of the day, the "antitrust" question is not about Apple v. Microsoft... it is moving more in the direction of "Apple & Microsoft" vs. anyone trying to claw and scrape their way into the game.
- eevilspock 11y ago
  Yet another addition to my list of Matthew Effect examples and how this effect may be enemy number one, undermining entirely the notion that an unregulated free market produces a level-playing field and a meritocracy.
  - brc 11y ago
    1) There are no 'unregulated free markets' 2) Nobody -ever- has said that an 'unregulated free market produces a level playing field and a meritocracy' The facts are that a regulated and controlled market with freedom of economic action produces the best outcomes for a population as a whole, when measured in life expectancy, social mobility and and even environmental cleanliness. Every other system that has been tried produces far worse outcomes across all these measures. There's a persistent adolescent thought pattern running these days which says something like 'free market? Huh? Where's my lamborghini? I got nuthin' but student debt and no job' This kind of thinking should be avoided in order to make progress on the topic.
- 11y ago
mathattack 11y ago
Matt Levine is awesome at separating arguments from interests, and writes very clearly. He was great on Dealbreaker, and I'm glad that he's not tempering his voice on Bloomberg.
guimarin 11y ago
As someone who derives most of his income from the value created by start-ups disrupting incumbents, I'm all in favor of index funds making firms anti-competitive in their own industries.
11thEarlOfMar 11y ago
Maybe it's upside down. Index funds effectively buy and sell at prices set by non-index fund investors. They are reacting to market price, not trying to predict where the stocks will go in the future. All other investors are betting on the future price moving one way or the other. I'd argue that index funds are an amplifier for demand, but that the actual demand is still generated based on 'analysis' by investors seeing the the current price as an opportunity.
chad_strategic 11y ago
Index funds and ETFs will work until they don't anymore. It always happens...
- sparky_z 11y ago
  What always happens?
  - chad_strategic 11y ago
    It's amazing how fast people forget the past. https://en.wikipedia.org/wiki/Tulip_mania https://en.wikipedia.org/wiki/Tulip_mania It happens every time, if there a way to make money speculators will come into the market, take advantage of it. Or in the case of index funds, it will become overcrowded and inefficient and the market will move on to the next big thing. Just ask LTCM. It's the invisible hand of the market... Honestly, anybody that down voted me is probably invested heavily in index funds because they heard something on a blog and listened to Warren Buffet once.
animefan 11y ago
One problem with this argument is that it ignores the fact that investors are also consumers. If the representative investor is also the representative consumer, then managers who aim to maximize shareholder utility will not set monopoly prices, but rather competitive prices! Of course, like the author I don't think any of this bears out in reality.
roymurdock 11y ago
Which institutional investor should I specifically be concerned about? Show me the institutional investor that owns 30% of American, 30% of Delta, 30% of Southwest, and 30% of United. [1] If this is the case, then yes we have a problem. The manager of this fund has a major incentive to have these 4 major firms collude and price gouge its customers, as competition among the firms would minimize profit for the index fund. It would major shares of the companies that own the entire market. I think it's safe to say that this institutional investor doesn't exist. Which concentrated group of 3-4 (oligarchy) institutional investors own a combined 50% of American, 50% of Delta, 50% of Southwest, and 50% of United? If this is the case, then yes, we have a problem. Collusion will occur between these funds, who will agree to use their voting/management rights to collude at the airline level, as they own the companies that own the market. We're usually used to seeing collusion between the CEO's and boards of major companies in concentrated markets because we tend to think of these people as the people who profit the most from price gouging. Antitrust lawsuits against AT&T, Kodak, Standard Oil - these are all pretty concrete examples of collusion from brands that we (used to) interface with. [2] Now we could be seeing collusion abstracted one layer - the owners/shareholders are institutional investors who don't have a well-known brand. Which institutional investors specifically should we be worried about? Unlike AT&T + Verizon, I don't interface directly with any of them, so I'm not sure which firms I should be concerned about. Where's the data? [1] 30% is an arbitrarily large number. [2] http://www.hg.org/article.asp?id=6025 http://www.hg.org/article.asp?id=6025
- nradov 11y ago
  Based on the latest market data, the largest holder of AAL, DAL, LUV, and UAL is Vanguard which through various mutual funds owns 11.5% of the total market value of those four airlines. Second largest holder is T.Rowe Price with 6.8% of the total ownership. Concentration of ownership goes down rapidly from there. So it's hard to see this as a real problem.
jwatte 11y ago
For an individual index fund, who is making the argument that it's big enough for anti trust? If one fund owns 1% of American Airlines, and 1% of United Airlines, they have no monopoly/dominating power over either.
morgante 11y ago
This is a fascinating line of thought and, at least from a game theoretic perspective, seems to be a mechanism for creating automatic, passive collusion between companies. If we model the market as a prisoner's dilemma where a lawyer is deciding whether their client should defect or not, mutual defection is the normal Nash equilibrium. But if both lawyers are representing the same client then cooperation becomes the dominant strategy: regardless of what the other lawyer does (cooperate-defect and cooperate-cooperate both have higher total payoffs than defect-defect). Notably, this mechanism is entirely passive: it requires no communication between managers or even managers and their investors. Merely knowing that my investors are also investors in my biggest competitor would make "cooperation" the dominant strategy without requiring any conscious collusion. Taken to the extreme, this actually undermines the entire free market: every manager in a 2+ place firm would have a fiduciary responsibility to drive their company out of business so that the first place firm could enjoy monopolist profits (and thus maximize their shared investor's total return).
assaflavie 11y ago
Say index funds become illegal, just for the sake of argument. Aren't they replaceable by an algorithm - trading software that balances a portfolio that copies an index per investor? It's less efficient, of course, but it's essentially the same thing. You get millions of tiny, cross-sector owners instead of few big index funds. So in that sense the argument in favor of banning index funds is really pointless. They're just one implementation of a strategy that investors could follow on their own, just less efficiently. Essentially, banning them is just a way of enriching brokers because of the expected rise in transaction fees.

307 points by chollida1 11y ago

Interesting. The idea is that index funds implicitly favor collusion between companies in the same industry since investors/institutions own the competing companies (perhaps even at the same weight). That is, an index owning both Coke and Pepsi may not be too keen on one slaying the other, but instead for them both to become bigger together, yet separate. There's also the idea that index investing "should" be considered illegal because of the possible antitrust issues. Also, the rise of index investing puts more favor to stock buybacks/dividends as opposed to reinvestment. The idea being (as an example) that the index would rather take Coke's profits and redirect to a smaller higher-growth-potential company (or even spread it out more evenly among all holdings). However, if no index investing, perhaps investors would be more willing to "ride it out" with Coke reinvesting a lot more profits back into the business (maybe the don't own Pepsi, or other soft-drink companies and want to see them all get demolished).

paganel 11y ago
In other words, there's no "silver bullet", no matter the industry. I also think that we should stop believing in the "wonder" of compound interest and act accordingly, because it will come a time when this "wonder" will prove to be just that: a thing that cannot last forever. The same goes for a guaranteed rate of return on investment.
- maaku 11y ago
  where did you pull that from?
  - paganel 11y ago
    As far as I've read "index tracking" is seen as this wonderful thing that cannot go wrong. Until it does. It's another way of saying "this time is different". The last part of my comment is related to the fact that "index tracking" and all the related "investment strategies" rely on the assumption that, over all, things will only go up, i.e. ROI will always be positive. I questioned that assumption. We cannot guarantee that in 30 years' time (let's say) we will still be able to return 3-5% on our huge piles of pension funds' money, no matter the strategy. What I'm saying is that we should be prepared for a stagnating or even deflationary world, financially and economically speaking
    - kspaans 11y ago
      It's almost entirely about paying less in fund fees and aiming to be 'average'. I.E. get the return of the market rather than trying to beat it. Think of it as 'passive' investing rather than index investing. EDIT: But yes, we don't know whether one can assume "The S&P500 will average 10% per year for EVARRRRR!!!1".
      - gburt 11y ago
        I'm not the OP or the grandparent post, but I wonder what happens if a significant portion of the market starts indexing? My gut is that there are strong incentives against that: as more people start indexing, the gains from not indexing become more diverse.
        debacle 11y ago
        On the same token, more indexing will insulate losses by creating an implicit demand based on market cap.
    - mcguire 11y ago
      You realize that the scenario you describe is equivalent to "the entire collapse of global civilization that will make previous dark ages look like candy and unicorns." I'm serious. If the overall economy is "stagnating or even deflationary" for any significant period of time, all of the wheels are going to come off. (Really want a dark thought? You realize that we've dug up and used all of the easily-available oil, right? When Some Later Generation Gets Its Act Together, they aren't going to have a convenient, cheap source of energy.)
      - JoeAltmaier 11y ago
        Information can no longer die - CDs, DVDs, libraries - a new dark age will be mercifully short. And as for cheap energy - there are plenty more, better sources than oil.
        11y ago
- ryangittins 11y ago
  What are you talking about? No one believes in the "wonder" of compound interest. They believe in the mathematics.
  - damoncali 11y ago
    I think the point the parent is getting at is that nothing about business guarantees constant, compounding growth. It's not just mathematics, it's population growth, productivity, capital distribution, etc. - lots of stuff that we take for granted that results in constant growth rates, but that doesn't necessarily have to.
    - im3w1l 11y ago
      Compounding interest could continue at the upper right part of the S-surve. If the interest decreases every year, and sufficiently fast, it could give rise to a convergent infinite product. So total wealth would never exceed the threshold of the possible.
  - crimsonalucard 11y ago
    While physical laws do not bound mathematics, they bound the reality and context in which we talk about "compounding interest."
- nemo44x 11y ago
  Compound interest accumulation, over a long enough period of time has historically ended in blood & ashes and redistribution.
  - Lawtonfogle 11y ago
    Capital could never be directly translated into power. Capital always had to be used to buy enough people who combined had power. Those people could refuse to be bought and instead join those without capital on moral reasons. Even as technology allowed us to use capital to increase the power of a small group of people, there still had to be a small group of people. But we are soon to hit a point where capital will be used to buy power directly thanks to advances in AI and robotics. We may never again have another cycle like you describe.
    - marcosdumay 11y ago
      To be honest, I fear this, because I consider it likely enough to fear, but I don't think it's the most likely outcome by a big margin. If you want to know the probable outcome of an Intelligent Capital vs. The People fight, just look how a big company defends its computer network against targeted hackers today.
- brc 11y ago
  Seriously. Sometimes I wonder about who actually is visiting this site. The 'wonder' of compounding interest? It's merely the monetary representation of the return on investment in productive activities and assets. The reason money has a cost is because it can be converted into useful, productive activities, so the holder needs to be compensated for that. The 'wonder' is how animal herds and horticulural products increase enough in quantity to feed us all. Building a shelter over your head is compounding interest at work. You sleep better, stay healthier and have more time to do other things. Same goes for a knife or a spear, or a factory or a computer. I find it incredibly odd that we have people running around saying 'we have to stop growth' 'growth is bad'. Yet, on all measurable criteria - every single one of them - things keep getting better. This is because of the compouding effect of investment in knowledge and productive capacity. I'm not sure where the growth-hate comes from, if it is ignorance or just some sort of strange moral fashion to hate on the modern world. Either way, a class of people have convinced themselves that - of the entire trajectory of growth from nomadic paleoithic peoples to now - it's right at this point the wheels are about to fall off. Strikes me as a little narcissistic, really.
  - paganel 11y ago
    > Seriously. Sometimes I wonder about who actually is visiting this site. I'm a programmer who sometimes reads about economics and economics history. I've also worked in some finance-related industry for a couple of years early in my career (in the IT department). > This is because of the compouding effect of investment in knowledge and productive capacity. Yes, I know how compound interest presently works, I was just questioning its long-term (think 50-to-100 years, if not more) viability. To give an example which I stole from people smarter than me, just think that if you had invested your pension money on the Russian stock market in the 1910s or on the Chinese stock market in the 1930s you would most probably be bust (to say nothing of nationalizations and confiscations of private real estate). And these are two pretty big examples which happened in the last 100 years. The idea that the return on the rate on investment on the long term can only go down I've stolen from Jean-Baptiste Say, who wrote it down in the ~1820s. Now, he just happened to write this before the Industrial Revolution started doing its thing and, just as important, before economic colonialism started to positively influence the Western economies of that time (think the Opium Wars). Now, you're saying that we'll be able to somehow reproduce that Industrial Revolution a second time, I question that optimism. > I'm not sure where the growth-hate comes from I'm not at all "hating growth" (even though I believe that we should be well aware of its downsides). I'm just saying that it's no good making only positive economic projections about the future, we're not magicians and crystal balls are just that, pieces of glass.
aetherson 11y ago
An index owning both Coke and Pepsi wants the soft-drink market to grow bigger -- it is presumably indifferent to whether Coke slays Pepsi, Pepsi slays Coke, or both grow bigger together, as long as the total market increases. Which is arguably a good thing. Let's say that Coke has 60% of the market and Pepsi has 40% of the market. If Coke's investors are separate from Pepsi's investors, then it would be in their interests to take a tactic that kills Pepsi and allocates half of its market share to Coke and the other half goes up in smoke to a smaller overall market -- now Coke is half again as big as it was! But the industry is smaller. That said, I'm not sure that realistically, market-decreasing tactics really exist in most cases -- I can't think of a real world example. The collusion argument is certainly interesting.
- makomk 11y ago
  More precisely, an index fund owning both Coke and Pepsi wants profits from the soft-drink market to grow bigger, and the easiest way for that to happen is for both companies to increase their prices at the same time. Note that this is exactly the opposite of how competition in capitalism is meant to work - it's meant to drive down prices towards the cost of production, increasing overall efficiency as it does. Note also that this likely also results in selling less soft drinks than if the companies were actually competing, because increasing prices generally decreases sales.
  - fweespeech 11y ago
    I'm not sure that is an actual problem. Generally, executives get compensated in stock in some way in their company. So the Coke C-Suite is motivated to compete with the Pepsi C-Suite even if the board members are the same for both companies.
    - eitally 11y ago
      I think it is a problem. Unless you've worked in one of these industries where there are a handful of major players and rough parity of capability between them (like consumables, electronics manufacturing, heavy industry, oil & gas), corporations trade execs on a regular basis, and when those execs jump ship for a competitor they often lure away a good number of their key staff, too. So not only do you end up with a bigger overall market if they all do well, you end up with leadership (both executive staff and board members) who knows the ins & outs of everyone. It is in everyone's best interest for everyone to succeed, but if a company falters significantly it becomes either an acquisition target or it slowly fades away as key talent migrate to competitors. Not only this, but if you attend the earnings calls for corporations in the same sector (or even better, if you're lucky enough to attend one of their investor & analyst days), you'll see firsthand how the analysts are wined & dined, and how closely everyone knows everybody else. It's a big game that creates a ton of wealth at the top -- as long as the status quo is roughly maintained and change is incremental.
rhino369 11y ago
Maybe the solution should be that index funds just shouldn't be able to vote their shares.

praptak 11y ago

Interesting. With enough optimisation of the mechanisms of modern capitalism we arrive at a state where a single amorphous entity owns the economy so there are no incentives created by competition.

uptown 11y ago
You could say the same for politics.
- danharaj 11y ago
  That is true if you limit yourself to preserving some political structure. It is not true if you consider revolutions and radical changes to be politically legitimate. There is no ideology or system you can encode in prescriptive rules that endures forever. Capitalism(s) has had a long run, but so did feudalism(s). I pluralize because those systems have changed. What happened to feudalism in the end was that its fundamental tenets were overthrown. What remained could not be called feudalism. It remains to be seen if and how that occurs with capitalism. What can be discarded to make the incumbent institutions endure? How long will that last?
- praptak 11y ago
  I don't think any political entity owns the economy. Quite the opposite - campaign funding is how the economy controls politics.
  - nickff 11y ago
    I have only seen recent studies finding that campaign spending has little impact on electoral outcomes; if you have evidence that elections can be bought, please provide it, so that I may be enlightened.[1] [1] http://pricetheory.uchicago.edu/levitt/Papers/LevittUsingRepeatChallengers1994.pdf http://pricetheory.uchicago.edu/levitt/Papers/LevittUsingRep...
    - praptak 11y ago
      "I have only seen recent studies finding that campaign spending has little impact on electoral outcomes;" It's a 1994 article and the research didn't stop in 1994. There are quite a few after-1994 articles supporting either view. "if you have evidence that elections can be bought" Influenced. Here's an example one from 2004: http://karlan.yale.edu/fieldexperiments/papers/00246.pdf http://karlan.yale.edu/fieldexperiments/papers/00246.pdf TLDR: authors designed and performed some actual experiments whose outcomes support the thesis that campaign spending works - better for a challenger than for an incumbent.

VLM 11y ago

The OSS model is instructive as an analogy. 80% and shrinking of the fund market is closed and proprietary software. Its very expensive and relies on single points of failure, often one person per fund. There's a lot of propagandizing that they're the only way to invest or best or whatever. 20% and growing of the fund market is free open source allocation, here is TODAYs definition of an index now buy stock to reflect it. Needless to say its incredibly cheap compared to the closed source funds and arguably gives an overall higher rate of return. Some of the lower rate of return of closed source funds is because of their massive advertising and propaganda budget spent to convince investors that they're a better deal. Sometimes, by obscure enough definitions of better deal, they are. Usually not. Needless to say someone who's paycheck depends on FUDing the free competition isn't going to have anything nice to say about FOSS or index funds. The idea that FOSS or an index fund is a conspiracy is kind of weird. If index funds are made illegal on that ground, I suppose Emacs will be made illegal soon because its unfair to make individual proprietary editor writers compete with the entire world teamed up against them. "The right of the rich to privatize gains and socialize losses shall not be infringed" and possibly other constitutional amendments will be marched out in the corporate press, etc.

stdbrouw 11y ago
The article is not about index funds competing with alternate investment opportunities and whether or not the competition is fair, it's about what index funds do to the competitiveness of the companies they invest in.
- VLM 11y ago
  Exactly, that's the best way to present FUD. Don't tell people you're trying to grind an axe, just say I'm merely providing free advice from my grindstone financed workplace.

curiousjorge 11y ago

Index fund works well because it's diluted. When you invest in a single company there are many unknowns and downsides but stretched across the sector, you find less risk (how likely is it that other than Toshiba and Kodak are cooking books). However, the returns are also limited to the sector as well. I admit picking undervalued companies AND being solvent enough before the market reacts rationally is a huge undertaking and why there's so little of successful value investors.

obblekk 11y ago

This is cool, but incomplete. An index fund would still want competition if by competing, Pepsi gains 100% and Coke loses 1%. i.e., in any case where competition grows the pie rather than cuts it up differently, the index fund would want competition. I claim this is the right result. We should discourage competition where everyone ends off worse, and encourage competition otherwise. Individuals competing do things like dump goods below cost to bankrupt smaller competitors; an index would perhaps not do that.

praptak 11y ago
"Everyone ends off worse" - by a strange definition of everyone that leaves consumers out of the equation.
- obblekk 11y ago
  Well, consumers shouldn't be much worse off, otherwise it creates an arbitrage opportunity. Although Pepsi and Coke may be indexed, they aren't the same entity allowing investors to just own one. If there's some action that Pepsi could take that would massively reallocate the pie in it's favor (by winning over consumer for instance), then investors ought to start massing to it and becoming more activist. This would come at the expense of the index of course. So really as long as there's easy 'severability' of the companies in the index, they shouldn't be overtly monopolistic. But I agree in industries with high capital requirements (energy, biotech, etc.) it may be impossible to separate out the companies and then they would be de facto merged. This really is an interesting idea because a solution seems hard to find. Outright banning indexing would be nearly impossible to enforce (large pension funds could reproduce the index at a slighter higher cost).
  - theseatoms 11y ago
    > Well, consumers shouldn't be much worse off, otherwise it creates an arbitrage opportunity. Only if the industry has a low barrier to entry.
- davidw 11y ago

deleted 11y ago

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cmsmith 11y ago

The article's focus on the temptation for collusion seems overblown to me. Yes, the interests of Pepsi+Coke's index shareholders are served if the companies avoid cannibalizing each other's value, but those shareholders have no way to apply pressure on the companies to do that. Index shareholders do not vote, and by their nature cannot sell shares of a company that they are displeased with. The other concern seems more well-placed. An efficient market requires that shareholders buy and sell companies in response to performance. Index funds buy and sell companies in response to the performance of the fund, or the market as a whole, or some other arbitrary factor. If 50% or 80% or 90% of a company is owned by 'dumb' funds, what does that do to their market value? And how could that affect the choices of the CEO?

kspaans 11y ago
Vanguard may invest passively, but they claim to do active things with their proxy votes: https://about.vanguard.com/vanguard-proxy-voting/ https://about.vanguard.com/vanguard-proxy-voting/
gnopgnip 11y ago
The index funds are rebalanced frequently. If an individual ticker is delisted(usually due to size or mergers) those stocks get sold.

deleted 11y ago

[deleted]

bickfordb 11y ago

If index funds create larger voting blocks of shares, wouldn't that create a more powerful pool of voting power to influence changes than if all shareholders were voting individually? Index funds could turn over voting control to a proxy/research based voting service or survey their investors to determine how to vote. I'm embarrassed to admit I actually don't know the voting policies of the major index funds I'm invested in (VTI, AGG mostly).

saryant 11y ago
http://www.vanguard.com/pub/Pdf/sai040.pdf http://www.vanguard.com/pub/Pdf/sai040.pdf Page 45.

elipsey 11y ago

The quote "stock acquisitions that create such anticompetitive horizontal shareholdings are illegal under current antitrust law" doesn't seem to include any reference that I can find to any original text written by Elhauge. Instead the footnote links to a bunch of the author's own articles about Elhauge. The only properly cited textual evidence offered is a series of denials by Elhauge that he ever said index funds are illegal. Levine has been writing about this for months in articles with linkbait titles like: "Should Mutual Funds Be Illegal?" (http://www.bloombergview.com/articles/2015-04-16/should-mutual-funds-be-illegal- http://www.bloombergview.com/articles/2015-04-16/should-mutu...) and "Labor Department Wants to Tweak Your Retirement Plan" (http://www.bloombergview.com/articles/2015-04-15/labor-department-wants-to-tweak-your-retirement-plan http://www.bloombergview.com/articles/2015-04-15/labor-depar...) It seems like Levine has an axe to grind with regulators, and doesn't want anyone to talk about research that might suggest regulation. He might be right, but he is making a crappy argument. EDIT: Ok, I stand corrected. Elhauge totally said that. It's in the abstract. I had trouble finding it because Levine cited himself instead of the paper at the end of that that paragraph. Sorry.

ikeboy 11y ago
That's a direct quote from the linked paper http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2632024 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2632024
anigbrowl 11y ago
More likely he just mixed up his URLs with his anchor text. Linked from 'Elhauge claims to disagree with my interpretation': http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2632024 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2632024

paulpauper 11y ago

index allocation as a % of total assets will keep rising, but total assets will also keep rising.. That means individual stocks will still have price discovery despite a futuristic scenario where 99% of all money is indexed. The mechanism for how this leads to collusion is unclear.

sandworm101 11y ago

Why the assumption that an index must represent a market? Wikipedia def: "An index fund (also index tracker) is an investment fund ... that aims to replicate the movements of an index of a specific financial market, or a set of rules of ownership that are held constant, regardless of market conditions." The OP only discusses the former, not the later. I see the point that an indexed fund tied to a specific market, the narrower the better, may bring antitrust rules into play. But the later concept, that a indexed fund is simply a fund with fixed buy rules, need not get anywhere close to antitrust. They need not have a presence across any "market" as conceived by antitrust. How about an indexed fund with the rule: Own equal numbers of share from all publicly-traded social media firms, except facebook. Such an indexed fund might find lots of investors without getting anywhere close to antitrust.

theseatoms 11y ago
Sure, index funds can track any sort of index, and use any sort of weighting scheme. But modern portfolio theory dictates that truly passive investors should hold two assets: the "market portfolio", and a "risk-free" asset such as Treasury bonds, or cash. As other commenters have mentioned, "index investing" is better referred to as "passive investing".
- sandworm101 11y ago
  I think the very term "indexed fund" is an artifact. Indexed funds need not be tied to an index. They can still be "passive investing" without the index. "Antitrust" is a similar linguistic artifact as you can violate antitrust rules without any mention of trusts,
  - theseatoms 11y ago
    I agree we should get away from the term "index fund", but for better or worse, investors are hung up on indices. Why do we talk about the S&P 500? Why not 1k? etc. Don't get me started on the price-weighted Dow...

dataker 11y ago

I just can't see it as something positive. This is signaling that monopolies have massive power in their industry horizontals. 'To compete', they must take over another industry horizontal.

bcg1 11y ago

A bigger problem with index funds is the inherent bias they create towards consolidation of capital at the top. A company that becomes part of the S&P 500 will automatically have bi-weekly buyers of their shares as people pump money into index funds via payroll deduction. Nearly every piece of mainstream financial advice in the US suggests such behavior... "d% of mutual funds fail outperform the S&P 500" etc. Of course such comparison ignores transaction costs, administrative costs, risk, diversification across asset classes, et al. However, it leads to many people who want to "Set it and forget it" to just buy the S&P 500 index companies automatically every 2 weeks, pumping up the values of large cap corporations whether they perform well or not. I know that companies don't necessarily benefit directly from an increasing stock price, but in reality it allows them to raise capital by issuing new shares with less dilution. Also it makes it costlier for smaller competitors to raise capital, crowding out competition. At the end of the day, the "antitrust" question is not about Apple v. Microsoft... it is moving more in the direction of "Apple & Microsoft" vs. anyone trying to claw and scrape their way into the game.

eevilspock 11y ago
Yet another addition to my list of Matthew Effect examples and how this effect may be enemy number one, undermining entirely the notion that an unregulated free market produces a level-playing field and a meritocracy.
- brc 11y ago
  1) There are no 'unregulated free markets' 2) Nobody -ever- has said that an 'unregulated free market produces a level playing field and a meritocracy' The facts are that a regulated and controlled market with freedom of economic action produces the best outcomes for a population as a whole, when measured in life expectancy, social mobility and and even environmental cleanliness. Every other system that has been tried produces far worse outcomes across all these measures. There's a persistent adolescent thought pattern running these days which says something like 'free market? Huh? Where's my lamborghini? I got nuthin' but student debt and no job' This kind of thinking should be avoided in order to make progress on the topic.
11y ago

mathattack 11y ago

Matt Levine is awesome at separating arguments from interests, and writes very clearly. He was great on Dealbreaker, and I'm glad that he's not tempering his voice on Bloomberg.

guimarin 11y ago

As someone who derives most of his income from the value created by start-ups disrupting incumbents, I'm all in favor of index funds making firms anti-competitive in their own industries.

11thEarlOfMar 11y ago

Maybe it's upside down. Index funds effectively buy and sell at prices set by non-index fund investors. They are reacting to market price, not trying to predict where the stocks will go in the future. All other investors are betting on the future price moving one way or the other. I'd argue that index funds are an amplifier for demand, but that the actual demand is still generated based on 'analysis' by investors seeing the the current price as an opportunity.

chad_strategic 11y ago

Index funds and ETFs will work until they don't anymore. It always happens...

sparky_z 11y ago
What always happens?
- chad_strategic 11y ago
  It's amazing how fast people forget the past. https://en.wikipedia.org/wiki/Tulip_mania https://en.wikipedia.org/wiki/Tulip_mania It happens every time, if there a way to make money speculators will come into the market, take advantage of it. Or in the case of index funds, it will become overcrowded and inefficient and the market will move on to the next big thing. Just ask LTCM. It's the invisible hand of the market... Honestly, anybody that down voted me is probably invested heavily in index funds because they heard something on a blog and listened to Warren Buffet once.

animefan 11y ago

One problem with this argument is that it ignores the fact that investors are also consumers. If the representative investor is also the representative consumer, then managers who aim to maximize shareholder utility will not set monopoly prices, but rather competitive prices! Of course, like the author I don't think any of this bears out in reality.

roymurdock 11y ago

Which institutional investor should I specifically be concerned about? Show me the institutional investor that owns 30% of American, 30% of Delta, 30% of Southwest, and 30% of United. [1] If this is the case, then yes we have a problem. The manager of this fund has a major incentive to have these 4 major firms collude and price gouge its customers, as competition among the firms would minimize profit for the index fund. It would major shares of the companies that own the entire market. I think it's safe to say that this institutional investor doesn't exist. Which concentrated group of 3-4 (oligarchy) institutional investors own a combined 50% of American, 50% of Delta, 50% of Southwest, and 50% of United? If this is the case, then yes, we have a problem. Collusion will occur between these funds, who will agree to use their voting/management rights to collude at the airline level, as they own the companies that own the market. We're usually used to seeing collusion between the CEO's and boards of major companies in concentrated markets because we tend to think of these people as the people who profit the most from price gouging. Antitrust lawsuits against AT&T, Kodak, Standard Oil - these are all pretty concrete examples of collusion from brands that we (used to) interface with. [2] Now we could be seeing collusion abstracted one layer - the owners/shareholders are institutional investors who don't have a well-known brand. Which institutional investors specifically should we be worried about? Unlike AT&T + Verizon, I don't interface directly with any of them, so I'm not sure which firms I should be concerned about. Where's the data? [1] 30% is an arbitrarily large number. [2] http://www.hg.org/article.asp?id=6025 http://www.hg.org/article.asp?id=6025

nradov 11y ago
Based on the latest market data, the largest holder of AAL, DAL, LUV, and UAL is Vanguard which through various mutual funds owns 11.5% of the total market value of those four airlines. Second largest holder is T.Rowe Price with 6.8% of the total ownership. Concentration of ownership goes down rapidly from there. So it's hard to see this as a real problem.

jwatte 11y ago

For an individual index fund, who is making the argument that it's big enough for anti trust? If one fund owns 1% of American Airlines, and 1% of United Airlines, they have no monopoly/dominating power over either.

morgante 11y ago

This is a fascinating line of thought and, at least from a game theoretic perspective, seems to be a mechanism for creating automatic, passive collusion between companies. If we model the market as a prisoner's dilemma where a lawyer is deciding whether their client should defect or not, mutual defection is the normal Nash equilibrium. But if both lawyers are representing the same client then cooperation becomes the dominant strategy: regardless of what the other lawyer does (cooperate-defect and cooperate-cooperate both have higher total payoffs than defect-defect). Notably, this mechanism is entirely passive: it requires no communication between managers or even managers and their investors. Merely knowing that my investors are also investors in my biggest competitor would make "cooperation" the dominant strategy without requiring any conscious collusion. Taken to the extreme, this actually undermines the entire free market: every manager in a 2+ place firm would have a fiduciary responsibility to drive their company out of business so that the first place firm could enjoy monopolist profits (and thus maximize their shared investor's total return).

assaflavie 11y ago

Say index funds become illegal, just for the sake of argument. Aren't they replaceable by an algorithm - trading software that balances a portfolio that copies an index per investor? It's less efficient, of course, but it's essentially the same thing. You get millions of tiny, cross-sector owners instead of few big index funds. So in that sense the argument in favor of banning index funds is really pointless. They're just one implementation of a strategy that investors could follow on their own, just less efficiently. Essentially, banning them is just a way of enriching brokers because of the expected rise in transaction fees.