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Weekend reading: Can we have too much of a good thing with indexing?

Good reads from around the Web.

We’ve been kicking around the “What if?” consequences of everyone using index funds for years in the comments of Monevator.

But it’s always seemed a very academic debate.

“What if everyone builds their moon home near the Sea of Tranquility? What will that do to lunar property prices? And will they at least upgrade the roads?”

However index fund dominance is starting to look less like science fiction, given the market share gains in the US in the past few years.

Some of our favourite bloggers also addressed this issue recently after famous hedge fund manager Bill Ackman attacked indexing as a “bubble” – and revealed he suffered from a common delusion about how market cap-weighted index funds work in doing so.

Plotting the index funds’ downfall

So this week, Abnormal Returns rounded up [1] what is becoming a fractious debate. (Remember Ken Fisher’s misguided article from last week’s links [2]?)

As Abnormal Returns’ editor Tadas Viskanta writes [1]:

One of the reasons why investors have flooded index funds of late has been because of their lower cost.

At some point this trend will lose steam because index fund fees are already pushing the zero bound.

However active managers are feeling the pinch.

Every major asset manager seems to be either launching a smart beta ETF or actively managed ETF.

Managers who are underperforming the market are finding fault in the indexing trend.

Tadas also introduces what he calls The Bernstein Curve, which looks to plot where index fund market share starts to work against stock market efficiency.

It’s a neat idea, though I think his suggested market share estimate is far too low.

I’d imagine index funds could probably take a 90% share of liquid markets before we saw any big changes in market efficiency.

Market efficiency is a woolly concept though, and nobody really knows.

Zero sum games don’t add up for most

Even if efficiency were to break down, I think most people would still be best off using index funds – because active investing is a zero sum game [3].

This implies that for every fund manager feasting on the greater inefficiencies we might see in an over-indexed world, another would be losing to the same degree.

And both would be charging higher fees.

Ironic, no?

It will certainly be interesting to see how this all plays out.

If indeed it does play out – as the growth in assets managed by market-lagging hedge funds has surely demonstrated, the desire to invest different remains a strong one.

Perhaps we’ll all become rich before we all become indexers!

From the blogs

Making good use of the things that we find…

Passive investing

Active investing

Other articles

Product of the week: The new 1.14% two-year fixed rate mortgage from Yorkshire Building Society [18] is the cheapest, says The Telegraph [19]. Market turmoil has inched such deals back towards their all-time low of 1.05% from the Post Office [20] last August.

Mainstream media money

Some links are Google search results – in PC/desktop view these enable you to click through to read the piece without being a paid subscriber of that site.1 [21]

Passive investing

Active investing

A word from a broker

Other stuff worth reading

Book reader of the week: Amazon has knocked £20 off its rugged Fire Kids Edition [38]. It expects the little darlings to use it to watch Disney movies, but who knows, perhaps they’ll start reading Monevator?

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  1. Note some articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”. [ [41]]