Industry Updates

Indexes are breeding like cockroaches. So what?

David Tuckwell

a close up of a bug
Three interesting and important ETF stories this week from around the web

1) What's so wrong with the proliferation of indexes?

Indexing is a profitable business and

so indexes are proliferating like cockroaches

. There are now more than 1 million indexes around the world, more than 20 times the number of stocks. Analysts often see this as both a sign of the times and a problem. But is it? There are more books than there are more words, more rulers than there are measuring systems, more gauges than there are metrics. Should indexes and stocks be any different?

2) Price discovery and ETFs

Some say ETFs are parasitic on active traders,

who do the hard work keeping the index honest

. This may be true, but the real question is how much price discovery is needed. At present active traders control 95% of stocks' trading volume. Is this much trading really needed to keep the index honest?

Some also say that ETFs distort markers. If this were true, active managers should be happy because it creates opportunities for arbitrage. But it's probably false - just look at stock markets. Every stock on the market is moving up and down intraday and throughout the week, as news, data and reports come in. If passive investing were distorting the market we wouldn't be seeing this.

3) ETFs are creating a self-fulfilling prophecy

The underlying idea behind ETFs is that

the index always goes up

(on a long enough timeline). But ETFs are in danger of making their underlying idea a self-fulfilling prophecy. When money goes into ETFs, it drives the index up (because ETFs buy the index). This then affirms the underlying idea behind ETFs: track the index because it always goes up. More investors then buy ETFs, driving the index up further and further justifying the underlying idea behind ETFs. If every investor did this the stock market would become a perpetual motion machine.


No ETFs to show.