What’s piqued my interest for my 50th post?
This week, in an editorial in the Wall Street Journal ahead of the release of his new book Stay the Course: The Story of Vanguard and the Index Revolution, John C. Bogle sounded a warning on the growth of index funds (1). The article is paywalled, and mostly taken direct from the book. I have replicated the crux here:
“Equity index fund assets now total some $4.6 trillion, while total index fund assets have surpassed $6 trillion. Of this total, about 70% is invested in broad market index funds modeled on the original Vanguard fund.
Yes, U.S. index mutual funds have grown to huge size, with their holdings doubling from 4.5% of total U.S. stock-market value in 2002 to 9% in 2009, and then almost doubling again to more than 17% in 2018. Even that penetration understates the role of mutual fund managers, as they also offer actively managed funds, and their combined assets amount to more than 35% of the shares of U.S. corporations.
If historical trends continue, a handful of giant institutional investors will one day hold voting control of virtually every large U.S. corporation. Public policy cannot ignore this growing dominance, and consider its impact on the financial markets, corporate governance, and regulation. These will be major issues in the coming era.
Three index fund managers dominate the field with a collective 81% share of index fund assets: Vanguard has a 51% share; BlackRock, 21%; and State Street Global, 9%. Such domination exists primarily because the indexing field attracts few new major entrants.
Why? Partly because of two high barriers to entry: the huge scale enjoyed by the big indexers would be difficult to replicate by new entrants; and index fund prices (their expense ratios, or fees) have been driven to commodity-like levels, even to zero. If Fidelity’s 2018 offering of two zero-cost index funds has established a new “price point” for index funds, the enthusiasm of additional firms to create new index funds will diminish even further. So we can’t rely on new competitors to reduce today’s concentration.
Most observers expect that the share of corporate ownership by index funds will continue to grow over the next decade. It seems only a matter of time until index mutual funds cross the 50% mark. If that were to happen, the “Big Three” might own 30% or more of the U.S. stock market—effective control. I do not believe that such concentration would serve the national interest.”
A range of solutions are then postulated, including references to a draft paper released by Prof John C. Coates of Harvard. The solutions are drastic, and most unworkable. They range through requiring index funds to spin off assets into independently managed entities, limiting each funds exposure to market sectors, requiring an independent supervisory board, to limiting corporate share voting rights of index managers. Perhaps the most workable is implementing full transparency and public disclosure by index funds of their voting policies. A ban on indexing has been hypothesised, but seems impractical and unworkable.
The Fire Starter pointed me towards a good retort by Cullen Roche at Pragmatic Capitalism (2, 3). The riposte is that not only are indexing firms a long way from owning 50% of the stocks on the market, never mind the 80-90% people are worrying about, but also that these firms invariably follow management decisions. These are not active firms. They are passive by their nature, and follow the natural flow of the company.
My own concerns comes more down to allocation. The FTSE 100 already includes Hargreaves Lansdown and the Scottish Mortgage Investment Trust (4). Neil Woodford’s Patient Capital Trust and Terry Smith’s Smithson have joined the FTSE 250 (5). Should the number of investment funds in these metrics begin to increase then allocating becomes recursive. The spread across FTSE 100 companies either becomes the FTSE 95 + 5 globally diversified funds, or the FTSE 95 alone, decreasing your diversification. If your aim is to stay invested in the top-performing UK companies then you get derailed. There is the potential to make your portfolio much more globally diversified, as some of those funds will track companies way outside your intent. It also has the potential that you end up with compounded holdings of companies you don’t want exposure to (*cough* FAANG *cough*). Not to mention the headache in calculating global and sector allocation percentages.
I’m merrily beavering away at my own allocation conundrums, but it appears to me that investors will need to put a lot more thought into strategies if they want to maintain a specific philosophy as more funds climb the FTSE ladder. Or they can just buy an All-World tracker. Different strokes…
Have a great weekend,
- The Trump vs China trade war has spooked equities investors (6)
- Prompting the US yield curve to (in part) invert. Lots of column inches on the risk of a recession (7)
- Intrigue from Canada, where the CFO of Huawei was arrested amongst concerns about the role of Chinese Government Intelligence in Chinese industrial products (and other things) (8)
- Lyft IPO expected early next year, with Uber to follow (9)
- Another energy company is sparking concerns – Outfox the Market repetitively hiking prices (10)
- Scientists have developed a universal 10 minute cancer test (11)
- The Welsh Government does some fairly interesting stuff. They’ve recently effectively banned new coal mines (12)
- Instead they’re going to be underground food farms (13)
- The Guardian Money team answer 20 pressing Qs (14)
- Do you live in one of Britain’s happiest places? (15)
- What happens when FIRE goes wrong (16)
- Monevator updated their savings goals post (17)
- RIT called FIRE last month (18)
- Firevlondon gives his November returns (19)
- As does the Saving Ninja (20)
- And LMF adds an Expense and Income report (21)
- As well as an Each Way Sniping report (22)
- And a reflection on her one year anniversary. Congratulations LMF! (23)
- MsZiYou gives her net worth update (24)
- FuMonChu over at FIUKMoney updates on their Nov ’18 net worth (25)
- Gentlemans Family Finances also updates with their Nov 2018 worth (26)
- Reflects on the best thing about business travel (27)
- And has a look at Abundance Investment, currently raising money itself on Seedrs (28)
- Indeedably, on what you consider normal (29)
- And I love this one on Subversion (30)
- YFG discusses the ‘double whammy’ of a longer life expectancy, with longer disability (31)
The kitchen garden:
- Completely missed that Agents of Field have moved to the country (32)
- Looking for a Christmas present? Sharpen your spades has a great ’10 best grow your own books’ list (33)
- Paul’s plots is a new allotment blog I’m following, based in London (34)
What I’m reading:
Religio Medici and Urne-Buriall by Sir Thomas Browne – the theological and psychological reflections of a C17th doctor. Getting to the end of this now, and it’s been a slog. Written in C16th prose, you really have to get your head in the right place. Some fantastic philosophical points, with moments of period debate thrown in; e.g. is glass the most divine substance as all can be rendered into it through fire?
Enchiridion by Epictetus – Bedside reading for a bad day