Union Pacific has a huge drive for constantly increasing efficiency. Their profits are up significantly year over year, but this fall they cut about 500 jobs from their headquarters in Omaha, around 6% of their Nebraska employees, and this isn't even the first time they've done it. To keep the big investors happy they are constantly searching for ways to cut costs.
On the other hand, this might also be a product of the industry. The railroad is necessarily growth constrained. It's unlikely that significantly more products will move to being transported by rail and there is very little room for new lines to be constructed.
At some point, the phrase "passive management > active management" will become verifiably false.
Is the argument that the vast majority of them could change their funds' charter to allow them to be actively involved with governance? If so, that would be really hard to achieve even if many of them worked at it.
Edit: three people have made the same "it's easier to get a controlling interest" argument. See my reply in the follow-up before making another redundant comment.
I'm not familiar with these non-intervention clauses, but in the 10/90 scenario haven't you made it much easier to seize control of the company? Now I only need 5%+1 of the shares to do as I wish?
If that was the case it would have been easy. Handful of people fighting for power.
But from what I can read the problem is exactly the opposite. As someone said below that Blackrock has been known to rubber stamp executive salary and maybe others follow suit. What is then stopping companies from going bigger and bigger on executive salary knowing that they will get rubber stamped from the funds?
What happens if there is a complex governance issue which requires vote and the index fund lack the motivation to ensure that they have weighed all the decisions correctly?
That's a funny contradiction of a sort - then the index fund becomes the agent it's supposed to be observing.
For one, Blackrock is not Berkshire Hathaway - and in reality, obviously Blackrock can't wake up tomorrow and decide to be. They're not built for that.
Another scary thing is that the market is being increasingly turned into a derivative, and the underlying asset becomes more volatile (certainly for many different reasons) as it becomes proportionally smaller .
[1] https://www.ft.com/content/4594f554-ba1a-11e7-9bfb-4a9c83ffa...
https://www.pionline.com/article/20170418/ONLINE/170419868/b...
The only large fund i know that regularly gets its hand dirty is the Norwegian sovereign wealth fund.
Which allows for them to do things like demand publicly traded recruit women to their boards. Which is a useful talent when you are focused on economic growth, and your holdings are focused on extreme paper-meritocracy that fails to result in actually addressing additional portions of a market because their talent pool can't perceive it.
https://newsroom.statestreet.com/press-release/corporate/sta...
oh no the potential.
I really doubt that he will ever come out and clearly say that they've become a bad investment.
But the insinuation is that going forward index funds might cause harm to public's interest. And law makers need to come up with laws to ensure that doesn't happen.
If the two companies are owned by the same guy, they have the incentive not to compete with each other since their owner cares about the sum of their profits. This is why one wouldn’t be allowed to acquire the other. But the effect is the same when a single index fund owns a large chunk of both companies. The companies are encouraged to compete not too fiercely with each other.
Also gets rid of any issues of fractional voting; they can track fractional votes in the internal vote, and then just round the result in the actual vote.
The biggest problem is that generally index funds try to take a pretty passive approach to management decisions (although they do vote in some circumstances). If the index funds allow their investors to vote on everything, to some extent they stop being an index fund that passively tracks the market.
That doesn't really follow. Tracking the index and voting are two separate concerns.
That's part of the point of Bogle's objections (I think - I can't read the article, I can only read about it), that they're involved in management already, even though that's not part of their mission. Simply voting based on a proxy vote of the fund's shareholders is arguably more "passive" for the fund management than what they're doing now, if you're concerned about passiveness.
Although I'm not sure I get that - I don't quite see how the renter's would be especially more short sighted - it's not like the fund is obligated to hold the stocks any longer than anyone else.
This logic is backwards; index fund holders are more likely to hold their shares for a longer period of time, compared to day traders. The whole point of index fund investing is to avoid short holds.
Apparently still in beta, so the site doesn't tell you much, but worth keeping an eye on.
[0] https://say.com/
If I'm wrong, can you explain what I'm wrong about?
Is this statement correct? Your argument hinges on it, so it's important to get a definitive answer.
The most visible sign of Vanguard’s engaged ownership is our funds’ proxy voting at shareholder meetings. We have an experienced group of analysts on our Investment Stewardship team that evaluates proposals and casts our funds’ votes in accordance with our voting guidelines.
Fund holders do not vote on corporate issues of stocks held by vanguard.
And of course, the owner of stocks held by a mutual fund are the mutual fund. Is that not clear to most people?
Bogle noted that trading would dry up if the stock market comprised only indexers and there were no active investors setting prices on individual issues. Everyone would just buy or sell the market.
...
Shareholders of index funds could then suffer more than owners of actively managed funds, and they could take their losses harder due to the perceived security they feel precisely because they merely own the market and aren’t trying to beat it. That might make active investors feel a bit of schadenfreude for indexers who have been free-riding at their expense, but the feeling probably wouldn’t last. The greater price swings that could ensue in a heavily indexed, less-active market are likely to exacerbate losses for everyone.
https://www.marketwatch.com/story/john-bogle-has-a-warning-f...
It seems a good bet that this warning, like most pre-downturn warnings, will only become obvious during the next major downturn.
Network -- 1976
* Full public disclosure by index funds of their voting policies and public documentation of each engagement with corporate managers.
* Require index funds to retain an independent supervisory board with full responsibility for all decisions regarding corporate governance.
* Make it clear that directors of index funds and other large money managers have a fiduciary duty to vote solely in the interest of the funds’ shareholders.
That's easy to say, but deciding what the shareholders interest is can be incredibly difficult. On any difficult decision, like "should this merger be approved", index funds taking any position is the same as active management.
Does anyone know of any investment risk to index funds if everyone is now doing it?
Which is to say the traditional more expensive managed funds that actually pay attention to the fundamentals of the companies they invest in should see a comeback. While this style of fund is more expensive (because a human can only examine a few companies in a year in enough detail to decide if they are worth investing in - as a full time job you can maybe do 50) by investing only in companies that will do better than average they can beat the market (or shorting if you want to play companies that will do far worse than average). So far the low costs of index funds have made them a better investment despite them not investing in strong companies, but we should see the day where a managed fund can beat the index funds just because the index funds are leaving the advantages of analysis on the table.
You can argue [meaning this might or might not be correct] that historically managed funds have done worse than index funds because there are so many managers that anytime there is a slight deal someone jumps on it before the deal is large enough to pay for the costs of finding it. However if you don't jump on it someone else will and they make something on the deal while you make nothing. Thus as index funds take over there will be more and more deals for the managers to find, and managers can wait until they are large enough to be worth the price.
It will be interesting to see when/where the line is crossed.
I think the main point is that index funds still rely on traditional market players to effectively allocate risk. And as index funds take up more of the market, they become less able to do that. Right?
In my view, index funds aren’t really passive at all, they are crowdsourcing the best ideas of active management. This is why many indices (like S&P 500) produce pretty good returns.
If you created an index held every US equity in equal proportions, regardless of price movement, that would be like what you’re talking.
If you compared the returns of the S&P 500 against this theoretical index (let’s make it an ETF and call it “DUMB”), you would find that the S&P 500 would have much better returns.
The takeaway from this is that many indices produce stellar returns and aren’t as “passive” as one might think. Think of factor indices or whatever.
Ultimately the problem domain of monitoring every publicly traded company and prognosticating their actions is huge, and the job is so messy that it will never be cheap. There should be an information theory paper on this somewhere.
The main investment risk to index funds growing is that, if everybody is a passive investor, then the passive investors are worse off as there are very few active investors who actually try and value companies appropriately.
On the other hand, if the market is littered with active investors, then the market is likely more efficient and 'correct', and so you're (probably) better off as a passive investor.
I'd rather see slower, predictable gains than bet my nest egg trying to go toe-to-toe with hyperefficient machines -- or hand it off to some Manhattan finance bro making that bet on my behalf.
Here's a pretty good article: https://www.aqr.com/Insights/Research/Alternative-Thinking/A...
Of course there is such a thing as price manipulation which active investors can try - if there are only a few and they work together this can work out. However the investors have incentive to cheat when working together as the cheater wins against his peers, thus this currently is confined to "penny stocks" (for example the company behind the stock doesn't exist anymore but they didn't properly delist their stock so technically it can be traded - you can buy such stocks for say a penny each and then hype them to suckers as the next big thing and sell for 10 cents each and make a killing - since the company doesn't exist no one else pays attention and the scam works.)
I didn't read past the paywall but one good thing if more and more people own index funds then they are participating in the success of those corporations represented in that index. Might tend to tone down some of the shrill agitation that everything "corporations" do is evil and greedy.
This sounds like the most viable strategy to me. Just don't let index funds vote. I don't understand his objection at all. The index fund managers are not long term investors in these corporations. The people who own the index's shares are, and they are deferring their votes to the managers right now.
If index funds start to create systematic valuation errors, active strategies start to perform better and they start to outperform index funds. This is not the case, because index funds beat active fund management constantly over longer periods. (The article raises concerns of corporate governance and accumulation of power that is different issue).
Matt Levine https://www.bloomberg.com/opinion/articles/2016-08-24/are-in...
>there is an alternative view that the rise of passive investing will improve capital allocation, because bad active investors will be driven out but good ones will remain. The passive investors can't influence relative prices, since they just buy the market portfolio, meaning that the fewer but better active investors will continue to make the capital allocation decisions. On this view, lower returns to active management are a sign that prices are more efficient and capital allocation is getting better
This was only the case because 'long periods' include the periods in which free riders (indexes) were small relative to the active and activist shareholders.
When was the last time they did that anyway? Or tried? For a while, Wall Street has been more interested in predictability or volatility than in actual risk. They flat-out don't care whether an investment will tank, so long as they can predict (or sometimes even control) the timing. Or use some minute technological advantage to reap the rewards before someone else does. The very nature of hedge funds is to be good at measuring potential arbitrage rewards, not actual risk. Copycat behavior only exacerbates a problem that already existed.
In theory it might only be one! If there's only one active investor, and they find stocks that the index funds have not priced correctly, then the active investor can pounce, make some money, and move the stock toward a more accurate price. The more they do this, the more money they will make, and the more resources they will have for finding and taking advantage of mis-priced stocks.
The real trick is telling what an "accurate" price is, so that you can evaluate whether the market is working properly. Since the purpose of the market is to find the accurate price, asking whether the price it finds is accurate seems like begging the question.
Is the stock market pricing risk accurately now? Was it pricing risk more accurately 40 years ago, before the growth of index funds? There have been plenty of bull and bear markets during that time... and some nasty unexpected shocks.
The problem is that (semi) manually trading securities is inherently expensive.
Funds solve that problem by massively reducing the number of transactions that are required: 1000 people investing in a fund investing in 1000 companies needs 2000 transactions instead of the 1000000 transactions needed when 1000 people invest in 1000 companies directly.
But there really is no fundamental reason anymore why you shouldn't be able to just buy small numbers of shares from a thousand companies via electronic systems. A million transactions is not really a problem for modern IT, nor is managing 1000 positions in your account.
Yes, there are some more practical problems (the valuation of individual stocks being too high for small investors to buy even a single one, preventing front running on index changes, tax refunds, ...) - but I would think all of those should be possible to solve in a way that is both economically feasible and has the individual investor holding the actual stock to prevent those accumulations of power. And you still could have the possibility to delegate your voting rights to some organization you trust--but that could be decoupled from the investment "product" or account itself, plus you wouldn't be required to delegate the power for all your investments.
Or we could just make laws that mandate that funds must delegate voting rights to their investors, i.e., make it as if they were holding the stocks directly in that regard?
Really, you don't. If you want to track a market cap weighted index, you only need to trade when the index composition changes, which isn't that often.
But also, that's not exactly something that couldn't be automated, is it? That could be a service offered by banks: automatically keeping your portfolio matched to a particular index.
The point isn't that you should be doing the work of a fund yourself, the point is that you should directly own the stocks. For one because that means you have the voting rights, but also because that would make you less dependent on any particular company. If you are invested in some company's S&P500 ETF, the only way to switch to a different company managing your S&P500 investment is by selling the old one and buying the new one, which causes transaction costs and can have massive tax consequences. If it was just your bank managing the stocks held by you, you could just transfer them to a different bank and have them take over the management.
(And also, it would allow minimally "active" investing even within a passive framework: If your bank is managing your portfolio for you, it would be much easier to, say, exclude a particular stock. It would technically be trivial to implement "S&P500, but without Facebook", say.)
> Moreover, most people probably don’t have the capital. You can’t buy a fraction of a stock, and since the S&P is market cap weighted you would need a lot of stock in order to do anything like the S&P 500
That is one of those things that I meant by "practical problems". If you think about it, that isn't really a fundamental problem. There is no fundamental reason why stock ownership has to be organized as "shares" that represent a fixed, relatively large, share of the company. We could in principle move to a model where you can hold more or less arbitrarily small pieces of a company, including arbitrarily small pieces of voting rights. Why shouldn't it be possible to just buy 0.00000000687 pieces of Berkshire Hathaway A for a cent or so, to have legal ownership of that piece, and to have the voting rights for that piece? None of that is exactly difficult to do with computers.
There were practical reasons why doing things the way we do them made sense, back when shares were physical pieces of paper that you moved around physically. But it really doesn't make a whole lot of sense anymore given our current technology.
The S&P500 had 500 stocks. Do you want to vote ~1.5 times a day?
That reinvents funds ... without the problem of accumulating all the power in a few hands, which was exactly my point?
> The S&P500 had 500 stocks. Do you want to vote ~1.5 times a day?
No, and why would I have to? For one, many index funds don't vote on many stocks either. But more importantly, the point is to unbundle voting rights from the portfolio management aspect. Just as that doesn't mean that you have to manually track an index, it doesn't mean you have to manually vote either, does it? You can just delegate it to some group that you think represents your interests, and you could do so selectively. If some group wants to get some particular company to change something and you support that, you could just delegate the voting rights for that one company to that group.
I worked for Vanguard and worked with the people who run the index funds, it's just a little harder than it looks.
Set a cap of $1 trillion or $500 billion that any single firm can have under management. This probably only breaks up Vanguard and BlackRock. Not sure how this would cause havoc. Seems like we need to relearn the reason anti-trust laws we passed in the US and start using them again.
I do think Vanguard has been a great boon for American investors and would not like them punished for their success. Not sure how to square that fact with the need to break them up.
Founders pitch supervoting control as a way to make sure the company can realize its long term potential by protecting themselves from activist investors with a short term view.
So far, ownership of new IPOs hasn't been affected much due to their small market caps and subsequent miniscule weighting in indices. It will be interesting to see if increasing concentrated ownership by index funds may eventually play a factor and perhaps increase acceptance of supervoting.
Index funds may even want to differentiate themselves by having good research teams to advise me on what to decide and having convenience options where I get to set specific generic voting policies that they will then implement automatically for me.
Now, you will most likely be uninformed about most of the decisions that need to be made, which lead to your 2nd point about default options suggested by the index fund manager. But that just circles back to Bogle's points in the article. Also, with index fund costs at rock bottoms, good luck getting quality research into your voting options.
The alternative is active funds where you're already paying for exactly the same thing plus a bunch of compensation for underperformance to people who pretend to know what they're doing. Paying a research team is cheap in comparison and once funds are at <0.10% expense ratios making them cheaper isn't that big of a market advantage anyway. A good research team and interface would definitely make me pick a 0.10% fund over a 0.05% one for a life-long investment career. If I'm reading the numbers in the article correctly at the scale of Vanguard that's a cool billion dollars a year to provide research and systems.
The common sense of not putting new laws until clear evil has been observed should be applied here.
That is the conventional approach, I think Mr. Bogle is suggesting that we act to prevent such issues ahead of time for a change.
And the main barrier to entry he refers to is essentially the size of the established players. They have economies of scale that a new entrant would be hard-pressed to match. And the author is the man who essentially invented the index fund, and whose company, Vanguard, currently is the market leader in these products and has the most to gain from maintaining the status quo.
"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."
I can attest that is absolutely 100% true. This business structure is perfect when economies of scale come into play. And S&P is a master of this. It's extremely difficult for others to compete with us because, like everything else, there is a range of services/quality. S&P is at the top end - the Mercedes of index providers. People pay more, but they get the best service/products. The margins are extremely high for any business. But for an service that is considered to have been "commoditized" (and it has to a large extent), our margins are insane. All our competitors want to attack those margins but they have trouble because they aren't able to provide the quality, variety, or depth of service that we do. Which leaves them only able to charge much less and be on the lower end of pricing. Time and time again I've seen some clients leave to go with someone cheaper and become displeased and end up coming back. That's because they simply don't have the internal systems, data contracts, or expertise from having been doing this for as long as we have.
Another thing is that the business model in general is damn near unbeatable. The 500 and DJIA combined require very little work overall as they are just two out of thousands of products we have. But they account for hundreds of millions of dollars in revenue. That's sort of like having a hit movie or book. But the difference with this business model as opposed to most other areas of capitalism is that the revenue is recurring. No where else have I seen unpatented, non-copyrighted intellectual property retain its value like this. Usually there is a surge at the start and then it tapers off fast after release/purchase. That creates a cash cow which they use to build stronger infrastructure and stay at the top.
That being said, let me address the main concern of the article - the issue of ownership for the index funds (not the index providers). I might very well be missing something here, but the answer seems obvious to me. They should just update the law so that the shares owned by the fund providers aren't considered theirs but rather the end holders of the ETFs/funds that they are packaged into. In fact this is so obvious to me I don't understand how it's not already the law since that's the case for a lot of other things like this. If you have a Charles Schwab account and issue an order for a buy, they buy it for you by placing the order under their trading ID on the market. You are later updated to be a holder of record during the trade settlement process. Schwab is a service/pass-through agent. It's very similar for the fund providers. They just buy the shares to package/securitize in advance and then sell to someone. This is the creation/redemption aspect of ETF management. When the creation/redemption process goes on or ETF shares change hands, a process similar to becoming a holder of record through trade settlement should occur. Yes, that would result in you technically being listed as owner of a fractional amount of shares, but that's a hell of a lot better (and easier to deal with) than saying that the fund provider owns all the shares and you just trust them to vote properly for you.
Which is a dumb idea, of course, as that just leaves the control over your capital to your adversaries. Passive investing works because goals are aligned: The only way to influence an index fund on the investing side of things into doing something stupid is by doing something stupid yourself. If you want to make an S&P500 index fund buy some penny stock, you have to buy it yourself first in massive quantities paying massive prices for it to drive up the market cap. Voting does not work that way.
I suppose it's possible to construct a law that says companies can conduct their voting as they have been, but they must also allow/accept late "votes" from fund managers but the requirement is that those late votes must conform to the same proportions.
[1] for example, you would need a $270,000 investment before you own a full share of SRCL.
Could you clarify this for me? I.e. who buys from you, and what is it they buy?
I suspect you could legally create a fund with the constituents of the S&P 500 without paying them, but you wouldn’t be able to advertise that fact easily.
An easy way to think of this is the retail example where you pay an investment advisor. You pay them to manage your money but they place all the trades through some broker. S&P is the investment advisor and the fund manager is the broker.
Would it be that hard to generate an index that had similiar exposure as an S&P index? Maybe not, but S&P is good at what they do and they have a lot of brand recognition.
