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How Billion Dollar Stock Market Index Funds Are Exposed to Manipulation That Can Damage US Investors



Dangers may lure index funds, a popular stock market area, known for their recent and consistent record of the top of actively managed funds, according to experts.

A recent summary in the New York Times alerts that the passive index funds may be subject to bias and possibly manipulation, as the interest in these funds has been ballooned over the past decade.

Read: Opinion: Why "craze" for index funds will not track the stock market

This is how Robert J. Jackson Jr., member of the Securities and Exchange Commission, and Steven Davidoff Solomon, professor at University of California, Berkeley, Law School, put it in an article Times article published February 1

8 in the New York Times:

But there is a problem: The indexes these funds are based on Cannot be as neutral as they work. Companies that prepare these indices face little regulatory control and can face significant conflicts of interest, which can harm US investors.

For example, MSCI added Chinese issuers to its emerging market index according to The Wall Street Journal's press from the Chinese government. Another conflict is when the index and fund are run by the same managers, which may be the case for highly customized indices.

Jackson Jr. and Salomon added to the Times article:

Conflicts of interest should worry about anyone invested in index funds, which includes many Americans with retirement accounts. Index providers have tremendous power. The decision to include a company in the S&P 500, for example, results in a redistribution of billions of dollars by investors money. Average company added to S & P 500 gains value; when it is removed, the stock price falls as the index fund sells its holdings.

In recent years, investors have largely abandoned actively-managed strategies in favor of passive in vehicles such as exchange-traded funds or ETFs that track the Dow Jones Industrial Average.

DJIA, + 0.03%

and S & P 500 Index

SPX, + 0.15%

for example. They include passive ETFs such as the SPDR Dow Jones Industrial Average ETF Trust

DIA, + 0.06%

familiar with its ticker "DIA" and SPDR S & P 500 ETF Trust

SPY, + 0.17%

known as "SPY". For example.

Active steering had been standard on Wall Street, and it was hugely popular in the dot-com era, when high-flying internet stocks mint star money leaders. However, in the current expansion, the old order has been disturbed by passive vehicles, perhaps forever.

Interest and cash flows have grown due to both better results than their actively traded counterparts, such as hedge funds and funds, and their relative low cost. Such passive ETFs track an index by composition and proportion and are not intended to strike a reference point but merely reflect its features. Such passive investments, as Morningstar has said, in a report last year, have "failed to survive and turn their references, especially over long-term horizons," especially when taxes and other charges are accounted for.

Morningstar says the growth of ETFs is driven by this massive shift in passive investment, as well as by Vanguard, founded by John Bogle. and BlackRock

BLK, -0.20%

According to Morningstar, total assets of US funds and ETFs reached a record just over $ 18 trillion at the end of 2017, a tripling of assets from $ 5.5 trillion just nine years ago. Nearly $ 6.7 trillion, or a third of these assets lived in passive funds at that time, the data provider said.

To be sure, not everyone with the views shared by Jackson Jr. and Salomon.

"It's hard to imagine an investment that is more transparent than index funds that publish stocks and rule on a daily basis. Investors who want to understand what's inside just need to do some homework. While we agree that is less regulatory clarity about which stocks fit the criteria the index uses, there is more than enough info to see the production, said CFRA Research Director of ETF & Mutual Fund Research Todd Rosenbluth MarketWatch by email on Tuesday.

Rosenbluth said examples offered by the authors in the Times Task "do not seem to apply … to vanilla fields that investors primarily have exposure to."


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