Are Index Funds Evil? (The Atlantic)

[WallStreetPhysician]

https://www.theatlantic.com/magazine/archive/2017/09/are-index-funds-evil/534183/

I thought this was an interesting read and worth sharing with the WCI community. My initial takeaways from the article are:

1) Index funds may or may not be evil - the academics are still sorting that out.

2) Anything in life has winners and losers; the article even states that the clear winners in the index fund revolution are ordinary investors, the clear losers are active fund managers and hedge funds, and the possible losers (under fierce debate in the academic world) are consumers.

3) If they are evil, it's not the investor's fault. The deleterious effects of index funds are its concentration of money into the hands of just a few fund managers.

What do you think?

-WSP

[Donnie]

Index funds don't work if there are too few active investors such that market prices are no longer representative of the fundamental value of the business.  I suspect that we are no where near that point though.

[Craigy]

The Atlantic so garbage.

[ENT Doc]

Donnie wrote:

Index funds don’t work if there are too few active investors such that market prices are no longer representative of the fundamental value of the business.  I suspect that we are no where near that point though.

Click to expand...

Not worried at all about this.  True, with all indexing you have no market.  But as indexing grows you have increasing arbitrage opportunities that can and will be exploited, which normalizes the market.  It works because index funds need active investors and active investors benefit from an increasing share of blind investments.  The article brings up my main concern with indexing, and that is who has control as a shareholder.  We'd all like to think we own parts of all these companies, but should we really consider ourselves owners if we are not exercising our voting capacity on a per-share basis?  Who is to say Vanguard will vote in our best interest?  Interesting things to think about.

[ajm184]

Areas where I believe indexing is having impact:

a. A much faster 'shake out' of active managers.  Too many managers/fund companies living on high ER/ bad ideas/ closet indexing.

b. Fees- More risk/reward with respect to ER at the retail level will occur, such as high water marks, performance fees, etc.  This will be very interesting as there will be mis-steps initially.  Active fund management will be much volatile endeavor from a financial performance standpoint.

c. Indexers- Will become more 'active' with respect to management proposals. The most impact felt upon executive compensation structure from greater scrutiny.  The heft to demand answers that retail investors do not.

d. Symbiotic relationship between active/indexers.  Active will be able to take positions in mispriced securities and achieve greater gains than indexers. Indexers will benefit from the actions of active to a lesser financial extent (i.e. free lunch) as mispriced securities achieve 'fair value'. Algo/HFT/Arb in turn will provide a close check upon active human fund managers.

 

[Dr.V. Investor]

you can check these academic papers:

Indexing and Stock Price Efficiency by Nan Qin and Vijay Singal  October 1,2015

Index Funds and Stock Market Growth by William N. Goetzmann & Massimo Massa, 1998

On The Economic Consequences of Index-Linked Investing by Jeffrey Wurgler

Why the Math Behind Passive Investing May Be Wrong by Wesley Gray, Wall Street Journal, Nov. 6, 2016

The Mysterious Growing Value of S&P 500 Membership by Randall Morck and Fan Yang, 2000

this is the latest one:

Is there a Dark Side to Exchange Traded Funds? An Information Perspective by Israeli, Lee, and Sridharan, January 13, 2017.

In this study, researchers from Stanford University, Emory University, and the Interdisciplinary Center of Herzliya in Israel found that when exchange-traded funds (ETFs) increase their ownership of a given company’s stock by just 1%, it makes the stock’s price 14% less correlated to its future earnings.

[Craigy]

ENT Doc wrote:

The article brings up my main concern with indexing, and that is who has control as a shareholder.  We’d all like to think we own parts of all these companies, but should we really consider ourselves owners if we are not exercising our voting capacity on a per-share basis?  Who is to say Vanguard will vote in our best interest?  Interesting things to think about.

Click to expand...

That's one thing that bugs me.  When I used to own individual stocks, all the time I'm getting voting and election stuff on the various companies.  I know my vote with 100 shares or whatever is functionally meaningless, but in theory each owner votes in his or her best interests, which translates to the interests of the shareholders.  In theory Vanguard will vote to maximize shareholder value as well, but this seems like a huge amount of concentrated control that we are giving to Vanguard, et al.

Not going to lose any sleep though.

[Hank]

Institutional Shareholder Services (ISS) plays a big role in advising big institutional shareholders on how to vote their proxies.  It generally is "safe" to vote the way ISS recommends and potentially risky to vote otherwise.

While I'm hardly a rabble rousing Marxist, I am a fan of greater shareholder democracy.  I don't think shareholders should pay outsized compensation to C-level executives for merely average performance.  Unfortunately, compensation committees on corporate boards often are made up of C-level executives at other Fortune 500 companies, so there's an incestuous relationship that rewards ever larger and more outlandish compensation.

I don't fully subscribe to the social democratic idea that the CEO shouldn't make more than 30 of 100 times more than the lowest paid janitor at the firm.  That said, the corporate board is supposed to work for the shareholders, not for management.  The board shouldn't give outsized compensation for merely adequate performance.  250 companies in the Fortune 500 have less than median performance.  Most of these CEOs should receive moderate compensation, not far greater compensation than their predecessors received five or ten years ago.

[TheHappyPhilosopher]

What a click bait title and pretty bad article. When mainstream magazines try and report on academic studies I usually stop reading. When is the last time the news media interpreted a peer reviewed medical study and got it right?