Are Index Funds a Trap For the Passive Minded?
Hedge fund manager Bill Ackman has seen the enemy of investors. And it’s in the form of a seemingly benign friend of many investors – the common market-weighted index fund.In his latest letter to shareholders of his fund house, Pershing Square Capital, Ackman starts out by discussing the reasons for his firm’s sharp underperformance relative to their index benchmarks last year. But he also devotes considerable space to criticizing index funds, which have been one of the fastest-growing segments of money management in the past decade.Indeed, Vanguard Group, the biggest provider of index-tracking products in the world, reported recently that it attracted $216 billion in inflows last year, the all-time record annual amount for any fund company.
And billions of dollars in recent years have also flowed into non-Vanguard index funds such as the SPDR S&P 500 exchange-traded fund (ticker: SPY ), the iShares MSCI EAFE ETF ( EFA ) and the PowerShares QQQ Trust ( QQQ ).Others in the alpha-chasing crowd have criticized the inherent nature of index funds for years. But Ackman comments are fairly lengthy and wide-ranging for a hedge fund manager, even going as far as claiming that the indexing movement is turning the U.S. into Japan.“At current rates of asset inflows, it will not be long before index funds effectively control Corporate America and the corporations of many foreign countries,” Ackman writes. “The Japanese system of cross corporate ownership, the keiretsu, has been blamed for decades of Japanese corporate underperformance and economic malaise. Large passive ownership of Corporate America by index funds risks a similar outcome without the counterbalancing force of large active investors and improvements in the governance oversight implemented by passive index fund managers.”Ackman’s main argument – and it’s a common knock on standard-issue market-weighted index funds – is that a purchaser is buying inherently overvalued stocks....MORE