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:
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:
- Vanguard is Telling You the Problem with Indexing
- Vanguard Founder Jack Bogle Sounds the Alarm on Index Funds
- Still Sure Indexing is Right for You?
- New Correlation Meltdown Could Punish the Indexing Miracle
- Another Legendary Investor Sounds the Alarm on Investments that Have Taken Over Nearly Half the Stock Market
Also, read my series on the Truth About the S&P 500. Reading it may change your mind about the value of indexing.
