
Hidden Dangers of the Great Index Fund Takeover - ikarandeep
https://www.bloomberg.com/news/features/2020-01-09/the-hidden-dangers-of-the-great-index-fund-takeover
======
darawk
The extremely simple and correct solution here is to not let index funds
_themselves_ vote. Only allow the votes to be cast directly by the index share
holders. Problem solved, I don't know why people keep hand wringing about this
and not suggesting the supremely obvious solution here.

~~~
lowracle
That doesn't solve the big part of the problem which is the co-ownership of
competing companies. A blackrock manager voting for you or you voting doesn't
change anything. Through the fund, you co-own multiple competing companies,
therefore you won't vote for policies that would increase competition between
those companies.

~~~
njarboe
I would say this does solve the problem. If you have enough money for your
vote to matter, then you can just own all the stocks in an index yourself and
get to vote. This is now even more practical as trade costs have recently been
cut to zero for all major brokerages.

The average index fund owner is also not likely be spending time looking over
the voting possibilities of 500 companies and aligning votes to decrease
competition between them, even if that was possible. They just wouldn't vote
on issues. The problem is that three funds can decided to vote on policies
that reduce competition between companies and that they are big enough for the
votes to matter.

Transferring votes to the underlying owners of the fund would in reality
likely just cause those votes not to be cast. It is similar to just saying
that the funds can't vote, but doesn't disenfranchise people who really want
to vote and still gives all those shares the index funds own possible power.

------
pochamago
I think at some point we'll hit a saturation point on passively managed funds.
What they're really doing is edging out the non profitable actively managed
funds, and forcing managers to prove they can beat the market if they want
investment. I also think we'll see more brokerages starting their own indices,
which will lessen the power of any individual fund

~~~
kccqzy
Well think of it this way. Since index funds replicate the market exactly,
then the non-index funds also on average replicate the market. It's just some
funds beat the market while others underperform.

~~~
jcrben
No. In theory we could have just two active (non-index) managers, and their
average returns certainly would not replicate the market.

------
stanferder
Isn't it possible for the index funds to simply _not_ wield the power they
have, and abstain from every vote? I was surprised that funds that are not
actively managed are still actively engaging with public companies.

~~~
rileymat2
I don't know how votes are counted, but will that make it impossible to make
positive changes? Or if they are not part of the total count, allow a minority
of shareholders to vote against the fund's interests?

~~~
stanferder
> [W]ill that make it impossible to make positive changes?

Yes, but that's consistent with the passive philosophy at the heart of index
investing. I was surprised that index funds had an active interest in anything
beyond reducing fees to customers.

------
hughpeters
This is such a fascinating problem. On the one hand Jack Bogle's invention of
the index fund has been so good for retail investors but because the process
currently requires a middle man - i.e. one of the big three - these index
funds have slowly become bloated with power.

What if the algorithm Vanguard uses was open sourced and could be self-hosted
by independent investors?

Where each investor owns their portfolio outright and adjustments to the
portfolio are made automatically by a free index manager bot that runs the
simple algorithm an index fund manager like Vanguard would.

Why wouldn't something like that work?

~~~
Forge36
Having spoken with few people, the process is still mostly people, building
algorithms in Excel. Much of what drives decisions is research, and personal
decision's, not automation.

I've heard AI trading has done very poorly as the system isn't predictable,
it's people making decisions in ways which can become self fulfilling
prophesies.

Algorithms when distributed would also fall victim to the fastest person
benefiting the most

~~~
biggestdecision
An index fund isn't doing research or making decisions though.

They invest in companies that make up an index. When a company enters the
index they buy units in that company, when a company leaves the index they
sell those units.

------
adaisadais
While this seems (incredibly) scary it makes me think that this could be a
huge opportunity for entrepreneurs (and some are currently undertaking it).

The fintech entrepreneur can carefully paint the picture of the dangers of the
big 3 while advocating for smaller index funds for a smaller set of investors.

This smaller set of investors can have stocks based on their individual goals
and interests. You just duplicate this over a lot more funds. The returns
won’t be as high initially but if the entrepreneur can convince customers that
this must be done it should help spurn new markets towards sustainability or
carbon reduction etc.

Edit: plz tell me if I totally misunderstood the article.

~~~
toomuchtodo
You just described M1 Finance (custom funds users can construct). Google
Warren Buffett’s Long Bet about passive vs active fund management (he won the
passive argument). Even sophisticated active investors are having a
tremendously difficult time achieving passive returns net fees. If you’re not
a sophisticated investor, I’d implore you to be cognizant of the challenges
you’ll face attempting active investment strategies, especially if you’re
investing retirement funds.

Passive index investing might not be perfect, but it seems to be the least
worst option when evaluating fund costs and risk adjusted returns, and we’re
aways off from significant second order effects.

~~~
pishpash
There are other use cases than returns, sometimes it has to do with
availability of funds or tax issues that constrain the possibilities. Even
something as simple as the full spectrum of risk tolerances and time-horizons
isn't well served by existing index retirement funds (they all skew to be
highly risky and equity focused). It's better to have the running of an index
fund be a separate service from the selection of its holdings or the choosing
of goals. Right now if you have a slightly different goal than the horde, you
can only go to expensive active funds, advisors, or spend a great deal of time
self-managing.

------
kds3
> Index funds “are great for investors,” says Elhauge, “but part of the reason
> they’re great for investors is exactly because of the anti-competitive
> effects.” Elhauge says the trusts of the late 19th century that gave rise to
> today’s antitrust laws also involved a form of common shareholding.

> She might want Coca-Cola to take big risks to crush Pepsi, and invest
> capital in new products and markets to do so. An investor who holds both, on
> the other hand, would prefer that Coke and Pepsi avoid price wars.

So the way we can solve this problem is to outlaw shares ownership of
competing companies? Seems like a fair solution.

~~~
pfortuny
No because that is essential for hedging, and hedging is good.

~~~
ellisv
I absolutely agree. If you could only invest in one tech company, who would
have invested in Apple/Amazon/Google instead of IBM? These are now large,
successful companies that were able to succeed because investors were able to
hedge and invest in an entire sector.

~~~
kds3
> If you could only invest in one tech company, who would have invested in
> Apple/Amazon/Google instead of IBM?

IMHO there shouldn't be Apple/Amazon/Google/IBM companies as they are today. I
want Google and other companies be splitted to AdWords, GoogleSearch, YouTube,
Android, Waymo companies. And they should not use their dominant/monopolistic
position in search/ads areas to get unfair advantage in other areas.

So you would have to choose your investment between Android/Apple/WinMobile
OS, AdWords/AdMob ads, Waymo/Cruise cars, Google/Yahoo/DuckDuckGo search,
YouTube/Vimeo videos.

~~~
dodobirdlord
Including DuckDuckGo in your list of search companies exposes one of core
issues that makes this idea unworkable. DuckDuckGo is basically just a skin
that shells out to Bing, Yandex, or Google.

------
vanniv
Are we really supposed to get excited about _Bloomberg_ whining about the
evils of index funds?

------
thedudeabides5
How about the danger of three corporations being responsible for _liquidity_
in 30% of these shares.

What happens if one of these companies goes down, and with it, a need to
liquidate 8% of Apple in a single day?

------
jl2718
Giant organization overseeing a huge number of competing interests and
accountable by proxy to millions of individual shareholders.

This sounds like a government. Maybe we’ll see voting for representatives and
parties.

------
chrisstu
I think there’s a bigger issue with passive inversing. Once an equity is in a
cap weighted index like the S&P 500 with a high weighting, like Apple, can’t
we end up in a situation where the individual company performance is
irrelevant? Nobody will sell Apple because they just own it through their
SP500 fund. As long as they are buying and holding the index fund, Apple
remains at a high valuation. The only thing that differentiates individual
stocks is active investors. And as they make up a smaller and smaller fraction
of over investment, they become less relevant.

~~~
javagram
AAPL and similar stocks do show their share price changing in response to
financial announcements, sales numbers, etc.

This concern is valid but I believe it only prevents price movement once a
much larger majority of the market is passively managed.

~~~
wutbrodo
I don't think it'd be much of a concern at a larger scale either. I stopped
actively investing a long time ago because it wasn't worth my time, but if the
market got to the point where it was responsive to reality, the increased
returns would probably draw me back in. And before me would be institutional
investors, picking up ~free returns. The system is designed to be self-
equilibriating in this respect

