The Full English Accompaniment – boggled by Bogle

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 Shrink

Side Orders

Other News

Opinion/ blogs:

The kitchen garden:

What I’m reading:

Fools and Mortals – Bernard Cornwell

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

References:

2 thoughts on “The Full English Accompaniment – boggled by Bogle”

Little Miss Fire says:

Dec 8, 2018 at 9:23 am

Hi! Thanks for the mention! WOW 50th post already! time sure does fly!

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weenie says:

Dec 8, 2018 at 12:36 pm

Congrats on your 50th post and thanks for another set of great links. Here’s to the next 50 posts! 🙂

The index funds issue is interesting but I too read the Cullen Roche post so I guess I’m not too worried about it right now. My portfolio is a mix of passive (index) and active in any case.

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