Bogle Sounds a Warning on Index Funds

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 .

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.

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.

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.

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?

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.

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.

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.)

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.

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.

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.

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.

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.

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.