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A bit click-baity, but the warning here from the father-of-index-funds is not that they've become a bad investment, but that their popularity is leading toward
by gregorymichael 8y ago
A bit click-baity, but the warning here from the father-of-index-funds is not that they've become a bad investment, but that their popularity is leading toward a handful of financial institutions holding controlling interests in most of the largest companies. Pretty interesting unitended consequence.
- fitchjo 8y agoHe is mentioned here pretty regularly, so many may already be aware, but Matt Levine discusses this and its variants a lot in his newsletter, most of the time under the heading "Should index funds be illegal?"
- sseveran 8y agoI have a hard time seeing it as unintended. If you are not promising any differentiation between yourself and the index than the only thing to really compete on is cost. There are economies of scale in finance, specifically if you need to optimize solely for AUM.
- davio 8y agoThere's definitely a race to the bottom going on with the free Fidelity funds and Vanguard reducing the dollar minimum by 70% for a lot of admiral shares.
- barrow-rider 8y agoVanguard is doing "Auto" Admiral too -- if you meet the 3k minimums for Admiral funds they're auto converting you anyway. Race to the bottom or not, competition works.
- refurb 8y agoYet another great example of "race to the bottom" benefiting consumers. Not sure why it's used in a negative way all the time.
- pmiller2 8y agoIt's used in a negative way all the time because the people using it are usually on the losing end of the deal.
- thisisit 8y agoBecause eventually businesses wake up to the fact that they need to make money. And they do it by going the absurd route. For example, online help is free but if you need to talk to a human being support, give us $10 a call or something. And while an average consumer might not be affected, people who are actually affected end up a nightmarish situation.
- refurb 8y agoBut that's just running a business poorly and you'll likely lose customers over it.
- mcguire 8y agoHow do these financial institutions vote their shares?
- soVeryTired 8y agoBlackrock have a history of rubber-stamping executive pay packages. In the past, they've voted in favour of proposed CEO pay packages in something like 99% of cases. Some people have argued that doing so benefits Blackrock execs themselves because high pay then becomes the norm. https://www.pionline.com/article/20170418/ONLINE/170419868/blackrock-opposes-shareholder-proposal-critical-of-firms-proxy-voting-on-executive-compensation https://www.pionline.com/article/20170418/ONLINE/170419868/b...
- walshemj 8y agoWhich is why I preferer UK Investment Trusts I can vote on the board and their remuneration.
- swarnie_ 8y agoMost vote with the board on all matters. The only large fund i know that regularly gets its hand dirty is the Norwegian sovereign wealth fund.
- wbl 8y agoThey follow ISS or similar.
- akimball 8y agoThe international space station? Islamic state in Syria?
- zimablue 8y agoA lot of them outsource voting decisions to companies which exist just to aggregate the most "corporate/sensible" way to vote. So the parent saying "they're not activist investors" is probably true, but then every single vote proceeding along "maximise profit according to a consensus view" lines probably isn't great for society.
- gammateam 8y ago> but that their popularity is leading toward a handful of financial institutions holding controlling interests in most of the largest companies. Which allows for them to do things like demand publicly traded recruit women to their boards. Which is a useful talent when you are focused on economic growth, and your holdings are focused on extreme paper-meritocracy that fails to result in actually addressing additional portions of a market because their talent pool can't perceive it. https://newsroom.statestreet.com/press-release/corporate/state-street-global-advisors-reports-fearless-girls-impact-more-300-companie https://newsroom.statestreet.com/press-release/corporate/sta... oh no the potential.
- dasil003 8y agoRight, because when shadowy groups get unimaginable leverage and power the first thing they do is apply affirmative action pressure to address gender imbalances.
- gammateam 8y ago> Right, because when shadowy groups get unimaginable leverage and power the first thing they do is apply affirmative action pressure to address gender imbalances. Yes, that is exactly what happened, dasil003 https://newsroom.statestreet.com/press-release/corporate/state-street-global-advisors-reports-fearless-girls-impact-more-300-companie https://newsroom.statestreet.com/press-release/corporate/sta... State Street has 2.7 Trillion AUM
- whatok 8y agoState Street also used that as a marketing stunt to launch an ETF while they were being sued for sexual harassment and pay discrepancies between male and female employees. Marketing is marketing is marketing.
- gammateam 8y agoyes, and also 300 companies added female directors nothing exists in a vacuum
- SilasX 8y agoWhy would that matter? If they are obligated by their funds' charters not to intervene, then all the governance decisions happen exactly as if they hadn't invested, right? 10% vs 90% of share votes being on auto-pilot shouldn't matter? Is the argument that the vast majority of them could change their funds' charter to allow them to be actively involved with governance? If so, that would be really hard to achieve even if many of them worked at it. Edit: three people have made the same "it's easier to get a controlling interest" argument. See my reply in the follow-up before making another redundant comment.
- timerol 8y agoIf 90% of shares are non-intervening that means hostile takeovers are now 10x cheaper to implement. It would be weird to be a company with market cap $100M, where $10M could buy a controlling interest in voting shares.
- SilasX 8y agoIt's not any easier (to a first approximation), because the share price will increase as you try to buy in, and the lower fraction of actively traded shares makes them that much more scarce and ramp up in value that much more quickly.
- walrus66 8y agoTo expound what you're suggesting, which is completely ridiculous, is that if someone buys 5.1% of actively traded float, the price will exponentially surge such that it would be equivalently priced to purchasing 51% of float in a market without a 90% passive stake.
- AnthonyMouse 8y agoNot only that, it doesn't account for short sellers. Index funds will happily lend their "passive" shares to anyone (i.e. short sellers) willing to pay interest. So if prices start to rise as someone tries to buy 5%+1 of the shares, others will rightly determine that the shares are now overvalued and start selling them short (especially if the buyer is expected to harm the company), allowing the buyer to keep buying at a minor premium over the original price. Or even at a discount, if the purchase is seen as inevitable and the damage they're expected to do gets priced in.
- nthot 8y agoAnecdotally, I have a few friends who work in the railroad industry and they are currently seeing something close to this. The company is almost entirely owned by large institutional funds. Union Pacific has a huge drive for constantly increasing efficiency. Their profits are up significantly year over year, but this fall they cut about 500 jobs from their headquarters in Omaha, around 6% of their Nebraska employees, and this isn't even the first time they've done it. To keep the big investors happy they are constantly searching for ways to cut costs. On the other hand, this might also be a product of the industry. The railroad is necessarily growth constrained. It's unlikely that significantly more products will move to being transported by rail and there is very little room for new lines to be constructed.
- pmiller2 8y agoYou forgot: there's a hard ceiling to how high they can raise prices, because they have to compete with trucks. Together, that all implies that if they want higher earnings, cost cutting is the only way.
- hangonhn 8y agoUh... not sure if that's actually the case. Trains are cheaper and actually faster over a long distance. The optimal way to ship is actually intermodal: ship for between countries/continents, trains for long trips over land, and then trucks for the last leg. They don't really compete with each other as much as they work together, especially since they have a standardized protocol for inter-process communication known as containers. Of course electric automated trucks could change all that.
- yourapostasy 8y agoBogle has gone on record that he believes the market efficiency limits of passive indexing are somewhere in the 70-90% range of equities held inside such broad market indexes [1]. A more reasonable and less click-baity headline would have been "Bogle Sounds Governance Warning on Index Funds". [1] https://www.ft.com/content/4594f554-ba1a-11e7-9bfb-4a9c83ffa852 https://www.ft.com/content/4594f554-ba1a-11e7-9bfb-4a9c83ffa...
- thisisit 8y ago> A bit click-baity, but the warning here from the father-of-index-funds is not that they've become a bad investment I really doubt that he will ever come out and clearly say that they've become a bad investment. But the insinuation is that going forward index funds might cause harm to public's interest. And law makers need to come up with laws to ensure that doesn't happen.
- conanbatt 8y agoIndex-funds also have a huge risk: as they become too large, they become distorting how pricing of companies work: i.e. just IPO'ing gets you purchasers. At some point, the phrase "passive management > active management" will become verifiably false.
- eloff 8y agoThis. I haven't heard anybody talking about this before, but it seems like there's an unavoidable tipping point here. I wonder if we've already reached it. Rightly or wrongly I trust my stock picking over an index fund now. At least I can take responsibility for the outcome.
- conanbatt 8y agoI think just as the market will find a balance between passive/active, individual investors will most likely also find benefit in doing part passive part active.
- xal 8y agoIt takes a long time and after IPO before useful indexes pick you up.
- xkjkls 8y agoYeah, it's not surprise that corporate governance is at its worse state in decades. Too many companies have boards filled with management sycophants who never due real work in guiding corporations in the interests of shareholders.