9 votes

The hidden dangers of the great index fund takeover

20 comments

  1. guy
    Link
    I don't buy the fear mongering. Index funds make up less than 20% of the US stock market. The vast majority of holdings are still in individual equities. Further, index funds tend to be...

    I don't buy the fear mongering. Index funds make up less than 20% of the US stock market. The vast majority of holdings are still in individual equities. Further, index funds tend to be buy-and-hold, so their share of US trading volume (and impact on price setting in the market) is much lower still, between 5-10%.

    Index funds are one of the greatest things to happen to individual investors since the creation of the market. Entrenched interests (active managers) are getting hit where it hurts so these type of scare tactics are to be expected, imo.

    Source

    10 votes
  2. [2]
    skybrian
    Link
    This is a subject that Matt Levine writes about from time to time, using amusing headlines like, "Should Index Funds Be Illegal" and "Are Index Funds Communist?" It is something financial...

    This is a subject that Matt Levine writes about from time to time, using amusing headlines like, "Should Index Funds Be Illegal" and "Are Index Funds Communist?"

    It is something financial journalists like to write every now and then. It doesn't seem like there is any actual problem at present, and there also isn't much agreement about what problems there might be in the future. It's more a theoretical dispute.

    Maybe the fundamental issue is apathy? Most investors don't care about voting, and they care even less about it if they indirectly own hundreds of different stocks.

    7 votes
    1. UniquelyGeneric
      Link Parent
      Not an expert on the subject, but my understanding of the risk of mass adoption of ETF investments is that no one actually knows what happens when a significant portion of capital is invested into...

      Not an expert on the subject, but my understanding of the risk of mass adoption of ETF investments is that no one actually knows what happens when a significant portion of capital is invested into the market as a whole rather than specific players (i.e. it has no historical precedent).

      I don't see an overtly bad reason to use ETFs, they avert many predatory and "non-value add" fees that the finance industry does not need to rely on (if they actually did a good job at investing). The real risk to index funds is that you put your funds at the behest of institutional investors, who over time who can manipulate markets. We're not anywhere close to that point of leverage, and it doesn't seem to be fast-growing, so I see it as a non-issue (for now).

      My real issue with index funds is that the best allocation of resources is to...not have a particular allocation of them. This seems to fly in the face of capitalism (which I'm not a fan of to begin with), but also negates the efforts of existing companies to draw retail investors (the unicorns are called so for a reason).

      I'm not an economist, but the only real takeaway I have with index funds is that everyone will lose together, and with a looming recession/depression the loss will be shared by all. We won't see a new family of Kennedy's that averted collapse, well, except for the woke neo-bourgeoisie who should have already diversified their portfolio away from the plebs like us on this forum...

      6 votes
  3. [3]
    Sybil_Fleming
    Link
    On a somewhat related note, the Wall Street Journal took a look at how smaller ETFs are struggling to gain inflows as more and more investors flock to big ETF players like Black Rock and Vanguard...

    On a somewhat related note, the Wall Street Journal took a look at how smaller ETFs are struggling to gain inflows as more and more investors flock to big ETF players like Black Rock and Vanguard for the perceived quality of their securities.

    3 votes
    1. [2]
      NaraVara
      Link Parent
      Is it “perceived quality” or just that those are where everyone’s 401ks are at and it’s easiest to keep it all in one place?

      Is it “perceived quality” or just that those are where everyone’s 401ks are at and it’s easiest to keep it all in one place?

      2 votes
      1. Sybil_Fleming
        Link Parent
        The WSJ article is talking about investors' choice in ETFs (securities, not brokers) being biased in favor of the biggest index fund managers because there are low fees, high liquidity, and little...

        The WSJ article is talking about investors' choice in ETFs (securities, not brokers) being biased in favor of the biggest index fund managers because there are low fees, high liquidity, and little risk of closure (ETF closures can incur unfavorable taxes). In essence it's creating a feedback loop where the big get bigger (bigger = lower fees due to economy of scale).

        Usually the brokers (aka account custodian) don't care which ETFs the investor chooses to buy so long as they're making money (from deposit interest, trading fees, upselling active funds or management services, administrative fees, etc).

        4 votes
  4. ibis
    Link
    Ethical ETFs are becoming more and more popular. I can't see any evidence that buying these shares will result in the company making more ethical votes on your behalf, but it would be a great if...

    Ethical ETFs are becoming more and more popular. I can't see any evidence that buying these shares will result in the company making more ethical votes on your behalf, but it would be a great if they could provide that service to investors and it would address some of the issues raised in the article.

    2 votes
  5. [2]
    NoblePath
    Link
    How can we as small, time retail investors choose to step out of them?

    How can we as small, time retail investors choose to step out of them?

    1 vote
    1. Sybil_Fleming
      Link Parent
      I must prefix my response with this: Despite the concerns raised in the article, broad market index funds are one of the greatest instruments for retail investors. I can think of two responses (I...

      I must prefix my response with this: Despite the concerns raised in the article, broad market index funds are one of the greatest instruments for retail investors.

      I can think of two responses (I don't work in finance and I do the boglehead strategy of buy-and-hold indexes):

      1. Purchase funds from another, smaller .financial institution. (e.g. Charles Schwab offers its own low-fee index ETFs.) This comes with the same risk of "not enough oversight" and additional illiquidity (thus higher spreads when buying/selling).
      2. Funds that use different strategies (e.g. Active funds, "ESG" funds, etc). These come with a significant risk of under-performance and closure if they don't have enough assets to become/remain profitable.
      5 votes
  6. [10]
    mightychicken
    Link
    Can someone explain why the voting power at these firms would lie with the brokerage and not be divided among millions of individual account holders?

    Can someone explain why the voting power at these firms would lie with the brokerage and not be divided among millions of individual account holders?

    1 vote
    1. [5]
      envy
      Link Parent
      Most investors don't care. Who has time to vote on 500+ corporate elections? It would increase the fees, and most investors want lower fees. Buying an ETF gives you fractional shares in 500+...
      1. Most investors don't care. Who has time to vote on 500+ corporate elections?

      2. It would increase the fees, and most investors want lower fees.

      3. Buying an ETF gives you fractional shares in 500+ companies. I would guess system isn't setup to support fractional votes.

      That said, I wonder why someone hasn't set up an ETF that always votes for one issue such as wealth inequality or global warming.

      8 votes
      1. [3]
        UniquelyGeneric
        Link Parent
        Public (terrible name for a company, FYI) started fractional shares of ETFs/stocks. Robinhood followed suit soon thereafter. Neither of these companies give a clear description of what a...

        Public (terrible name for a company, FYI) started fractional shares of ETFs/stocks.

        Robinhood followed suit soon thereafter.

        Neither of these companies give a clear description of what a fractional share/vote means. I assume it means nothing since these companies are woefully under-regulated (read: time to invest), and a single vote means nothing to the tech giants.

        3 votes
        1. [2]
          envy
          Link Parent
          Robinhood aggregate and report votes on fractional shares purchased directly. But not for ETFs.

          Robinhood aggregate and report votes on fractional shares purchased directly. But not for ETFs.

          1 vote
          1. UniquelyGeneric
            Link Parent
            Cool. I haven’t paid enough attention to it all, but I’m glad there isn’t a pure “screw the plebs” mentality (not saying it doesn’t have incentives for the higher ups regardless).

            Cool. I haven’t paid enough attention to it all, but I’m glad there isn’t a pure “screw the plebs” mentality (not saying it doesn’t have incentives for the higher ups regardless).

            1 vote
      2. mightychicken
        Link Parent
        It's one thing to own shares and choose not to vote (as I would be doing, in the scenario you described). It's another for a brokerage to basically annex their customers' shares and vote on their...

        It's one thing to own shares and choose not to vote (as I would be doing, in the scenario you described). It's another for a brokerage to basically annex their customers' shares and vote on their behalf without consulting them. That's too far of a logical leap for me (not denying that it's happening). Has anyone tried contesting this in court? The brokerage literally doesn't own the shares they're voting on behalf of.

        1 vote
    2. Sybil_Fleming
      Link Parent
      Broad market Index funds usually own shares in hundreds if not thousands of companies across many industries (and sometimes nations). There is no way for a retail investor to vote meaningfully at...

      Broad market Index funds usually own shares in hundreds if not thousands of companies across many industries (and sometimes nations). There is no way for a retail investor to vote meaningfully at that scale, so they often appoint the fund manager as their proxy voter to represent their interest.

      3 votes
    3. [2]
      UniquelyGeneric
      Link Parent
      A buyer is buying the index/market, which is objectively decided. There is no voting power. An ETF has power over which stocks are included (just like the Dow Jones or S&P 500 are allowed to...

      A buyer is buying the index/market, which is objectively decided. There is no voting power.

      An ETF has power over which stocks are included (just like the Dow Jones or S&P 500 are allowed to choose which stocks they track). This is decided by those creating the ETF.

      Index funds are based upon existing rules (e.g. I will invest proportionate amounts into whatever the S&P 500 decides to include). ETFs have a slight edge in that they could track any potential market (e.g. an ESG)

      2 votes
      1. just_a_salmon
        Link Parent
        The way voting works with mutual funds and ETFs is the individual investors elect a few people (employed by the company managing the fund) to vote for them. In other words, the individual...

        The way voting works with mutual funds and ETFs is the individual investors elect a few people (employed by the company managing the fund) to vote for them. In other words, the individual investors in the fund cede their fractional voting rights to the company that operates the fund.

        1 vote
    4. just_a_salmon
      Link Parent
      As an individual investor in an ETF or mutual fund, I theoretically* have tiny fractions of votes spread across potentially hundreds of equities. The usual way of getting around 1) the scheduling...

      As an individual investor in an ETF or mutual fund, I theoretically* have tiny fractions of votes spread across potentially hundreds of equities. The usual way of getting around 1) the scheduling issues of voting in hundreds of elections, and 2) the tiny amount of voting power I have in each of those elections is to let representatives of the company operating the fund to vote for me.

      * I say theoretically because I don’t own shares in the individual equities, I own shares of the mutual fund.

  7. just_a_salmon
    Link
    Wouldn’t majority (maybe not plurality) employee ownership fix this? Give each employee N votes so that as a block, they match the owner of the most stock in voting power. Not that I think this is...

    Wouldn’t majority (maybe not plurality) employee ownership fix this? Give each employee N votes so that as a block, they match the owner of the most stock in voting power.

    Not that I think this is a huge, looming threat.

    1 vote