Potential Index Fund Component Loses 98%

By Travis Wolfe @ Shutterstock.com

If you want to get an inside look at how the sausage is made with certain index funds, take a look at this story by Jacky Wong in The Wall Street Journal:

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The giants of passive investment need to get more active.

Marble mining company ArtGo’s 3313 117.86% Hong Kong-listed shares fell 98% Thursday after index compiler MSCI, MSCI +1.24% in a rare U-turn, dropped its plan to add the company to its indexes. MSCI said the decision followed further analysis and feedback from market participants about the stock, which had soared 3,800% this year. A Heard on the Street column Wednesday may have helped concentrate minds.

The brutal reaction—$5.7 billion evaporated in a matter of hours—reflects how important the compilers have become as trillions of dollars pour into index-tracking funds globally. Yet these companies have been slow to shoulder their newfound responsibilities as the de facto regulators of capital flows.

Mostly they hide behind the argument that index inclusion is based on objective, quantitative criteria such as market capitalization and turnover. But following a purely mechanistic process is precisely what makes the system vulnerable. And given the rising popularity of passive investing, there is likely no shortage of people willing to try gaming it.

The index fund alarm bells have been ringing for a while now. Here’s some of what I’ve written on the subject in the past:

Also, read my series on the Truth About the S&P 500. Reading it may change your mind about the value of indexing.

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E.J. Smith - Your Survival Guy

E.J. Smith is Founder of YourSurvivalGuy.com, Managing Director at Richard C. Young & Co., Ltd., a Managing Editor of Richardcyoung.com, and Editor-in-Chief of Youngresearch.com. His focus at all times is on preparing clients and readers for “Times Like These.” E.J. graduated from Babson College in Wellesley, Massachusetts, with a B.S. in finance and investments. In 1995, E.J. began his investment career at Fidelity Investments in Boston before joining Richard C. Young & Co., Ltd. in 1998. E.J. has trained at Sig Sauer Academy in Epping, NH. His first drum set was a 5-piece Slingerland with Zildjians. He grew-up worshiping Neil Peart (RIP) of the band Rush, and loves the song Tom Sawyer—the name of his family’s boat, a Grady-White Canyon 306. He grew up in Mattapoisett, MA, an idyllic small town on the water near Cape Cod. He spends time in Newport, RI and Bartlett, NH—both as far away from Wall Street as one could mentally get. The Newport office is on a quiet, tree lined street not far from the harbor and the log cabin in Bartlett, NH, the “Live Free or Die” state, sits on the edge of the White Mountain National Forest. He enjoys spending time in Key West and Paris. Please get in touch with E.J. at ejsmith@yoursurvivalguy.com To sign up for my free monthly Survive & Thrive letter, click here.