Index investing has been a hot topic for investors. Most fund managers rarely beat their benchmark index, so investing with the index seems like the best route to take for those not interested in doing the investment research work. Today, indexing has gotten so large that there are some concerns rising to the top that investors need to be aware of.
Three of the largest fund companies control or passively manage 80% of the index based funds within the US. Blackrock, State Street, and Vanguard handle approximately 15.5 trillion dollars of indexing investment funds currently.
Index Investing & The Big Three
Blackrock is the largest holder with approximately 7 trillion dollars invested, Vanguard is the second largest with approximately 5.6 trillion dollars invested, and State Street has approximately 2.9 trillion dollars invested. Putting this in perspective the thrid quarter 2020 GDP for the US was 21 trillion dollars according to bea.gov.
One of the problems surfacing is the passive management of these funds means that much can be lost to the best interests of the shareholders, and the potential loss of anti-competitiveness due to corporate management not being pushed by shareholders. Many investors invested in these funds don’t vote their shares, so it falls into the laps of the fund providers. With the amount of money they have under control this makes these three companies incredibly powerful shareholders.
Currently a few stocks comprise a large portion of the specific funds pose additional concerns. For example, the QQQ which mirrors the Nasdaq 100 has been a great performer, since it’s three largest stocks Apple, Microsoft, and Amazon account for almost 30% of the fund’s holdings. The fourth and fifth stocks Tesla and Google take the holding up to the mid thirties percentage wise. As the top few stocks get larger and garner a bigger portion of the index the diversification of the fund changes.
If an investor isn’t too careful and chooses to invest in the SPY which mirrors the S&P 500 stocks and the QQQ the investor has now combined their holdings to a larger quantity in Apple, Microsoft, Amazon, and Tesla as these stocks also make up the largest holdings of the SPY index.
Standard and Poors which owns the S&P 500 is a business, and therefore there’s good reason why their top holdings are similar to the QQQs top performers. The S&P 500, in an subtle way, is an actively managed fund. It’s holdings get removed and added to behind closed doors periodically for various reasons. Some of the reasons are surely to protect the business of the index. If their index becomes irrelevant comprised of old tired companies that aren’t growing with the economy, what good is the S&P 500 as an indicator and an investment?
Today, both the QQQ’s and the S&P percentage holdings are dominated by tech stocks. QQQs IT stocks equal 47% and the S&P portion of technology stocks equals 33% currently. If tech stocks reach overvalued then the investors within the index funds are also experiencing this same effect, since the ETF they are invested in mirrors the index.
Indexing certainly is a good way to build wealth slowly over a long period of time. The approximate return for almost twenty years of the SPY from March of 2000 till January 22, 2021 equates to about 276%, and the QQQs return for the same period equates to about 240% percent for the same time frame.
As a comparison here are the returns of a few US companies for the same March 2000 time period till January 22, 2021 as above: American Express: 287%, US Bank: 375%, McDonalds: 803%, Costco: 869%, Home Depot: 551%, Lockhead Martin: 2,559%, Disney: 415%, Amazon: 4,813%, Microsoft: 560%, and ofcourse Apple: 13,144%.
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