Index funds may be conspiring against the very same investors who fund them

Say it ain’t so.
Say it ain’t so.
Image: AP Photo/Richard Drew
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Normally, you’d think your 401k is a force for good. You put money in, let your nest egg grow, and draw it down when it comes time to retire.

But Harvard Law professor Einer Elhauge argues that the mutual funds that make up your 401k, along with everyone else’s, have become so immense that they have created a perverse anti-competitive incentive: to keep prices high in industries like airlines and banks, thereby hurting you, the consumer.

In a paper published online (pdf) July 24, he lays out the case thus:

  • There are only a few major investment firms (such as BlackRock, Vanguard, Fidelity, and State Street) that together handle most of the low-cost financial products (such as index funds) that underpin retirement accounts.
  • The firms manage a lot of money (trillions of dollars in customer assets between them), and it can only go so many places.
  • As a result, funds end up owning large chunks of companies that compete against each other, especially in concentrated industries like airlines and finance.
  • These cross-holdings discourages the companies from competing against each other, because they would have to lower prices, and therefore their profits.

Among the examples Elhauge brings up are tech giants Apple and Microsoft, pharmacy giants CVS and Walgreens, and banking giants JP Morgan Chase, Bank of America, and Citigroup:

Elhauge thinks the government should strengthen anti-trust laws restrict index funds’ investing capabilities: ”To avoid these anticompetitive problems, index funds must at some point either stop growing, give up any voting influence, or become indexed across industries rather than indexed across all competitors in each industry.”

This argument has been around for a little while. Bloomberg View’s Matt Levine pondered the issue back in April, when the research that inspired Elhauge’s paper first surfaced (paywall):

Managers mostly own shares of their own companies, but their biggest investors are diversified, and now there’s some evidence that their diversification has some effect on the managers’ decisions. That influence might well be good for investors as a whole. And, who knows, it might even be bad for competition.

When the Wall Street Journal’s Jason Zweig asked some asset managers (paywall) about Elhauge’s findings, they denied any such Machiavellian tendencies.

“We are not investing in companies for the purpose of running them,” said Glenn Booraem, who oversees corporate-governance activities at the Vanguard Group.

But if Elhauge and his like-minded counterparts are right, the index funds’ intentions may be beside the point: It is the very structure and scale of the funds that creates these anti-competitive incentives, not the people who run them.