You Can Take My Index Fund when You Pry It from My Cold, Dead Hand

How should you invest if you’re not a Warren Buffett-level stock picker? Take Warren Buffett’s advice:

My advice . . . could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the . . . long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions, or individuals — who employ high-fee managers.

Index funds are passive investment funds: instead of having researchers try to pick stocks that will perform better than the overall market, which is hard and expensive, these funds try to match the market by buying all of the securities in the S&P 500 or some other index. Thanks to their low cost and difficult-to-top returns, index funds have become increasingly popular in recent years.

So of course some people want to make them illegal.

A recent New York Times op-ed by Eric Posner, Fiona Scott Morton, and Glen Weyl argues that the institutional investors like Vanguard who run large index funds are violating the Clayton antitrust act, since by design they own stakes in many or all of the competitors in certain industries.

Vanguard and BlackRock are the largest owners of Apple and Microsoft, and among the top three owners of CVS, Walgreens and Rite Aid. If you zoom down to, say, the market in cooking stoves, you will see that the largest owners of two of the three major competitors — GE, Whirlpool and Electrolux — are Vanguard, BlackRock and State Street. The same patterns appear in airlines, soft drinks, you name it.


Economic theory tells us that when a single investor owns large stakes in competing firms, the investor will want firms to keep prices high and wages low. Price and wage competition lowers profits and stock values.

In other words, firms typically compete for market share. But if those firms are owned by the same people, then the owners don’t care if Pepsi gains a bit on Coke — they want Coke and Pepsi to maximize their overall returns, possibly by charging higher prices for soda than they otherwise would.

The evidence this is happening is not exactly overwhelming, coming from all of two academic papers looking at a single industry each (airlines and banking, respectively). But that doesn’t stop the authors from offering a solution to this supposed problem that would dramatically curtail our investing choices: have the government end indexing as we know it.

[T]he government should enforce the Clayton Act against institutional investors while recognizing a safe harbor for those that either take a small stake in an oligopolistic industry (less than 1 percent of each company) or invest in no more than one company per industry. BlackRock could own a large stake in United or Delta or American or Southwest, but not all of them.

In other words, institutional investors like Vanguard could keep indexing so long as they . . . started picking stocks. Which would mean research and trading whenever their assessments change. Which would raise their costs and make it less likely their returns would track the market. Which would be an index fund . . . how?

Nor is this just an attack on index funds. It’s an attack on any institutional investor who owns large stakes in companies — and a call for government to micromanage how they invest. I could explain how this sounds an awful lot like central planning, and how central planning has devastated every economy in which it has been tried. But what’s really galling is the sheer injustice of it all.

When Vanguard’s Jack Bogle created the first index fund forty years ago, he faced skepticism and even derision. It was only after a long struggle and proving that he was right — that Vanguard’s index funds did offer a superior value to customers — that Bogle’s company achieved its current dominance.

And now, because he succeeded on such a grand scale, a few professors waving studies want the government to declare the business model he pioneered illegal. Why? Because their models show that sometimes, in some industries, indexing will lead companies to conclude that it’s not to the interests of their shareholders to compete as hard on price, causing their customers to pay somewhat higher prices.

Well, maybe. But so what?

There’s a moral premise underlying antitrust that businesses exist to serve consumer (and sometimes worker) satisfaction. Everything a business does — raise or lower prices, offer new products, lay off employees, merge with other businesses, make a profit — has to be justified by showing that it maximizes the well-being of consumers.

This means that businessmen like Jack Bogle and Steve Jobs have a duty to come up with new ideas for amazing products or services, risk their time, money, and reputations trying to make those ideas successful — and, if they do succeed, endure the indignity of having their business decisions second-guessed by the representatives of “the consumer,” i.e., of anyone who has attained the exalted status of having contributed nothing to the creation of their business. 

Such a view is demeaning to businessmen and patronizing to their customers.

Ayn Rand offered an alternative moral framework for thinking about the relationship between businessmen and their customers — what in Free Market Revolution Yaron Brook and I have called “a fellowship of traders.”

On this view, buyers and sellers are seen as independent equals pursuing their own self-interest through voluntary exchange. Neither is serving the other: they are trading value-for-value. Each side has the right to decide the terms on which he’ll trade. Sellers decide what to produce, how to produce it, and what prices to offer — and buyers decide whether to accept the deal or, if they don’t like the terms, go their own way. A seller no more has to justify his pricing by proving that it maximizes the well-being of the buyer than the buyer has to justify his decision by proving that it maximizes the well-being of the seller. (No, that doesn’t lead to “monopolists” holding buyers hostage.)

The NYT authors end by asserting that their plan to destroy indexing would “raise living standards while making American companies more competitive.” But if we really want businesses to thrive and Americans to prosper, we aren’t going to get there by crippling passive investing — it’s to actively oppose central planning technocrats who think they’re entitled to control businesses they did nothing to create.