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John Bogle is Wrong About Index Funds

Summary:
It takes an unusually stupid person to disagree with John Bogle so I’m happy to announce that you’re reading that unusually stupid person. I’ve disagreed with Bogle on numerous occasions in recent years: 1) No, ETF’s aren’t dangerous. 2) There’s no such thing as passive investing. 3) Home bias is bad. So, I’m back for more. This time, Bogle says concentration in index fund assets is bad. Specifically: “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.” I think this

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It takes an unusually stupid person to disagree with John Bogle so I’m happy to announce that you’re reading that unusually stupid person. I’ve disagreed with Bogle on numerous occasions in recent years:

1) No, ETF’s aren’t dangerous.

2) There’s no such thing as passive investing.

3) Home bias is bad.

So, I’m back for more. This time, Bogle says concentration in index fund assets is bad. Specifically:

“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.”

I think this view, like many concerns over indexing, is overblown.

Let’s think about this in an extreme sense. For instance, if Vanguard owned 100% of all stocks via index funds then they’d own all the voting rights in US companies.¹ That sounds scary, but is it? Or is it in-line with the ethos of Vanguard? After all, if Vanguard owned all those voting rights and opted not to vote (or just voted in-line with management as they normally do) then they’d be doing what any good indexer believes by ignoring the urge to try to influence and pick the winners in the public markets.

Now, in fairness to Bogle (who doesn’t need my fairness), if Vanguard chose to behave more like an activist investor or corporate raider then that would be more alarming, but there’s two issues with this view. First, the big three indexing companies own just 17% of US stocks. Second, according to Morningstar the large indexing firms follow management decisions in over 85-90% of cases. So, not only are the big indexing firms a long way from owning the majority of stocks, but even in the case that they do, they will tend to vote in a highly passive manner. In short, the indexing firms are doing what the underlying shareholders would probably do anyhow (by either not voting or just deferring to management).

So, I say let indexers eat the world. Let them control more of the voting rights. That way firms like Vanguard can do what their indexing shareholders believe and leave the management of corporations (mostly) to the executives who actually manage the corporation.³

¹ – Okay, as I’ve explained before, this is impossible as there will always be active investors on the other side of “passive” indexers, but it’s useful for this particular case to think in extremes.²

² – Okay, okay. Vanguard can’t own 100% of stocks via index funds, but let’s say they owned 75%. Well, that would leave 25% of presumably better informed “active investors” to vote on corporate actions and Vanguard would mostly follow executive recommendations. That doesn’t seem so bad to me. 

³ – Okay, okay, okay. My real point here is that Bogle’s concerns are overblown. It’s impossible for indexers to control the entire stock market. And even if a small handful of indexing companies did own 51% do we  believe that corporate America would start operating differently than the existing corporate America where 10% of the population owns 84% of the market? It’s not like concentration of control and voting rights is some new phenomenon….

NB – Sorry for the click-baity headline. I think John Bogle’s right that most investors should index.

Cullen Roche
Former mail delivery boy turned multi-asset investment manager, author, Ironman & chicken farmer. Probably should have stayed with mail delivery....

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