41 years ago, the first index fund came to market in the US - in other words, a fund that tracks the performance of a particular market (usually equities) one to one. The idea of forecast-free investing has since developed into a magnificent success story. Every year, in the US alone, investors pull around 150 billion dollars out of expensive, forecast-driven so-called "active" funds and invest it in low-cost index-oriented products, above all in their exchange-traded variant, the ETF. In the interests of its clients, quirion is playing its part in this revolution.
True to the motto "the more enemies, the more honour", critics are increasingly speaking up too, pointing to supposed dangers with index funds and ETFs. The sources are often fund managers who operate on the basis of forecasts and are losing revenue massively due to the trend towards index funds. Above all, three accusations come up again and again:
"Criticism of ETFs is growing louder - and three accusations carry particular weight."
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First accusation
If all market participants "thoughtlessly" buy shares via index funds, then their price no longer reflects the fundamental, actual value of the companies contained in the index.
This view culminated in 2016 in an analysis paper by fund manager Inigo Fraser-Jenkins titled "Passive investing is worse than Marxism". The thesis: the stock market only works if investors put time and money into analysing companies in order to form a view of their fair values. If this doesn't happen, companies would be traded at the wrong prices and would therefore also receive capital in a distorted way. The consequences would be even worse than the central allocation of resources in socialist economies.
The current fuss over the analysis is surprising, because the topic was already conclusively analysed back in 1980 by Nobel laureate Joseph Stiglitz. The scenario described is nothing more than theory. Because to bring about such a scenario on the financial markets, all investors would have to hold index funds exclusively. According to estimates, only five percent of global trading volume can currently be attributed to index funds. In other words: 95 percent of trading is still based on forecast-driven and therefore expensive, speculative and - in the sense described - superfluous trading. It's hard to believe that genuine market distortions would occur before this share has fallen to 50 percent or even ten percent.
And even then, a few forecast-driven investors will already be enough to form correct prices. A comparison makes it clear: very few of us check every single price on every supermarket trip and compare it with all the relevant prices at the competition. Nevertheless, supermarket prices are a fundamental result of supply and demand. It's enough for some customers to go bargain-hunting and compare prices meticulously for those prices to find their equilibrium. But to demand this kind of price research from every supermarket shopper would be a pointless waste of resources: the prices would simply be the same.
Second accusation
If all investors hold stakes in all companies worldwide (which is advisable for diversifying investment risks), then company management no longer has any incentive to outdo competing companies. After all, the shareholders - and thus the owners - of one company would at the same time also hold stakes in the competitors. In this way, all companies would be shielded from competition in a gigantic cartel.
This accusation is likewise far-fetched, because there is no evidence that the representatives of ETFs and index funds behave in a less investor-friendly manner than the representatives of the classic fund industry. Studies point - if anything - to an improvement in management oversight.
Third accusation
Index investments may work in times of rising markets, but investors will flee these products at the next stock market crash and return to actively managed concepts. The "index fund" spectre currently haunting the markets is a bubble and will dissipate again - and with a big, crisis-fuelling bang.
This accusation, too, is grossly exaggerated. It's true that index funds will lose value in a crisis in parallel with the market. That's precisely what makes an index fund an index fund: it replicates the market exactly, in downturns too. What's false, however, is the claim that forecast-driven strategies would consistently outperform the market in a crisis. Mathematically, only every second forecast can be right: a (in this case correct) sell tip is always inevitably matched by a (in this case wrong) buy opinion, because in every stock market transaction there are both buyers and sellers. For every fund manager with an above-average return there is another with a below-average return. In a crisis, too, both sides charge high fees for their forecasts, which regularly turn out to be no better than a coin toss. So even in unfavourable market phases, it remains true that, thanks to their extremely low costs, index funds will outperform the average after-cost return of forecast-driven strategies.
Some may have considered socialism a good idea, but in reality it did not prove its worth. With index funds it's the other way around: theoretical thought experiments may perhaps be used to stir up worries here, but in reality the invention of these low-cost products is the best thing that could have happened to investors. That doesn't mean, however, that there are only good products in the ETF and index fund segment. On the Xetra exchange alone, investors can now choose from more than a thousand ETFs. A professional product selection, as quirion automatically offers its clients, is therefore absolutely essential.
