It’s clearer than ever that the actively managed mutual-fund industry, after 75 years of dominance, has succumbed to competition from low-cost indexing. There’s no one to blame but the funds themselves: They charge investors a lot more for inferior performance, which goes a long way toward explaining the multitrillion-dollar shift in how Americans invest their money.
This disruption has been driven largely by the recently deceased Jack Bogle and Vanguard Group, along with BlackRock Inc., State Street Corp. and others. My Bloomberg colleague Eric Balchunas has looked at the total cost savings of indexing, and calculated that the plunge in fees charged for investment-management services, otherwise known as the Vanguard effect , has saved investors about $1 trillion in fees.
Entrenched interests profiting from the status quo has been unwilling to give up that much revenue without a fight. And so active-investing advocates warn us that low-cost indexing is “worse than Marxism,” is “devouring capitalism” or is “lobotomized investing.” The litany of complaints doesn’t end there: Passive investing is “distorting market liquidity,” creating a “mania,” and is a “frightening risk” to markets; indexers “ignore fundamentals,” and are “terrible for our economy.”
Judging by money flows, none of these critiques have carried much weight with investors.
Last week’s Morningstar Investment Conference served as a reminder and is the jumping-off point for today’s discussion. Barron’s reviewed a panel session with the title “Are Index Funds Eating the World?” University of Chicago law school professor Eric Posner argued that “the concentration of ownership, particularly by the Big Three indexers, BlackRock, Vanguard Group, and State Street, can hurt consumers.”
It’s pretty hard to see the justification for this claim. The three intensely competitive fund managers he cited fight for market share and customers, driving costs for consumers to almost nothing — and in some case cases, to nothing at all. And didn’t we just note that indexing has saved investors $1 trillion?
Posner argues that competition among companies creates a strong incentive for innovation, lower prices and better service. But then he pivots: Because these public companies are partly owned by the same big index fund companies, eventually we will see less pressure to compete and innovate. The reason is that big shareholders benefit when companies can keep their prices high, not when they engage in cutthroat price competition.
Posner cites the airline and banking sectors as examples of where prices have gone up as “common ownership” has increased.
Here’s one big problem with Posner’s analysis: he cited two industries that have seen notable price increases while ignoring the reasons those prices rose.
Let’s start with the airline industry. During the past 15 years, the 10 major U.S. airlines have been merged into four carriers, eliminating unprofitable and non-viable rivals. This has indeed reduced competition and has led to price increases.