Are ETFs Killing Future Stock Market Returns?

might need to think about the space overall. So joining us, um, Joining you on this episode of Trilliance was Martin Schmalls, who's a professor at the University of Oxford's Business School where he teaches finance and economics. He recently wrote a paper. CO wrote a paper index funds, asset prices and the Welfare of Investors. Why did you want to talk to him? Yeah, UM, passive is growing. Ets taken all this money, index fense

taken all this money, and people like to study them. Um. People have been commenting on the rise of passive in the worries. You know, it's a whole chapter in my vocal book. Some worry and there's been all these worries and UM, this particular person I've met over Twitter and we've debated a little bit. Nice guy, UM, really smart. I think between the two of us, he brings up

our average i Q about fifteen points. As you can see from his credentials, he knows what he's doing and he's studied in his latest paper, the idea that index funds might even be too good for their own good because they're so good and cheap. They're basically allowing more people to come into the market and that is going to decrease expected returns in the future, which UM is to the it doesn't benefit anybody going forward. It's sort

of like bad for the common good. And this is one of a couple other common good arguments UM that have been made by academics. So we also discussed common ownership, which is another one which we'll go into. I won't you know ruin it now, but basically, if you are an next funder passive owner, UM, you know what what is happening with your money? Like, what are the larger ripple effects and implications? Is there anything to worry about? Do we need public policy on this and that's what

we explored, and we covered a lot. You know, I know you weren't here, but we I must have asked them twenty questions. We delved into it and the deep weeds. This is probably why you're needed on this show, because I don't think we would have got as deep maybe for this episode. It was a good thing though, because we really nerded out. But I will say he was real good about being short with his answers so he

doesn't go on and on. It's a it's a nice back and forth about several of these sort of concerns over the rise of index funds and passive. I think you'll enjoy it, especially if you're anybody at all interested in how markets work. Is famine Trillians Martin Schmall's alright, So Martin, welcome to the show. We've never met in person. We've interacted on Twitter here and there, and I've gotten to know you a bit over the years through digitally, I guess. So it's nice to have you on and

finally meet you. And I think we have the you know, pretty nice civil debates on this, as I do with many other people. This concept of passive is a is a concept that is studied, because it's getting bigger and bigger. As you know, I tend to write off most of the worries. A lot of them come from active managers. You're an academic, so I think that gives you some objectivity that I would give you a little more attention.

There's a couple issues we're going to bring up. Let's go over your latest paper, though, just give me the what's it called? Like, what is this sort of thesis called? And what is it? What is the worry here that you're looking at UM? So the papers called index funds, as at prices and the welfare off investors. And I wouldn't say that we're looking at a particular warrior. We

didn't start with the warrior. We started with a question, and the question is simply how indexing textbook indexing, you know, holding the market portfolio UM would affect the level of S prices and how that would affect investor welfare. So that's what we started out with. And I suppose one could say that it leads to a warrior. I would just call it a result, which is that it raises a surprices the level of a survices and thereby reduces

expected returns. That's the baseline of the finding. So Matt Levine, who's got away with words, who many people know rich for Bloomer opinion. Here's how he put it. An index fund is a good way to hold stocks. It has low fees and offers their versification. Therefore, if index funds are easy and cheap, more people will invest in the

stock market. Then if there were no index funds, this will push up the price of stocks, pushing down their expected returns, and therefore index funds are bad for investors. So that is exactly accurate. Um, I think pretty much every step of the way here should be obvious and mostly un arguable, except the last. Perhaps the last one at least was not obvious to me, and it's still not to present obvious to me. That is just what the computer simulations spit out. So bad for investors in

this case means reducing welfare of investors. That's a welfare part in the title. So I totally agree with the characterization of Matt Levin that the product. Well, let me ask you this, then, is this really an index fund issue? Mutual funds were introduced a hundred years ago. You could argue they brought in a ton of investors, and up until the late nineties of active mutual fund assets or mutual fund assets was an active funds. So was that a similar issue? Then, like why is it index funds

and not mutual funds in general? So this is fair what you're asking here, and um, there's no distinction in the model between an active fund or UM an index fund. In fact, there are no active funds in the model. The only thing that matters is whether it has become cheaper to hold a diversified portfolio. And that's obviously what index funds do, and much more successfully than active funds,

which is you know why I hold inext funds. So if active funds had similarly brought down the cost of holding a diversified portfolio, they would also riise UM and enterprises and thereby reduced returns and as a result of reduced investment welfare. So in some ways it's really about financialization. Um, then about index fense. I think that's fair. So I guess we already concluded that it's not about passive versus active as much as much of the debate about passive

investing really is. So a natural reaction to this would be well, some people argue not enough people are invested, like here in America only fifty of the population has any exposure to stocks and bonds, right, And this is added to the wealth gap because you know, you're getting

that equity market premium and the income from bonds. And so as someone who replied to me on Twitter at economic he said this, why is it better for people to be investors in steef twelve percent return then for fifty people to be investors and receive eight percent return? I would almost go further and say, well, what about a percent investors? Like I guess your thesis almost seems like you're rooting for only some people to be invested.

That's that's a really that's a brilliant question. This is really really good. Where do we start? So, first of all, it is true that without cheap index funds, you would mostly get the very rich and least risk averse people to hold the equities, and they would get them for cheap, right, because the returns are high because nobody else is buying them, And indeed that would lead to a widening of wealth and equality. And that is true in the model as well.

And as you make holding a diversified portfolio cheaper, say by the introduction of an index fund, say, um, more people invest, And you're exactly right that this actually reduces the difference between the expected well of the very rich and the middle class. It reduces wealth inequality. So what I thought the intuition was going to be of this model is that the very rich get harmed by the introduction of index funds, but the middle class and you know,

the poor would actually benefit. But it just turns out that this is not the case. It just turns out that the middle class had held a much smaller fraction of stocks to start with. They also get hurt, and get hurt enough by the reduction, and they expected returns that on net, they don't actually benefit. And that's a surprising part of the result. I'm not sure I like it,

but that's what the math says. Are you sort of saying that index funds or mutual funds in general, especially as they get cheaper and cheaper, which again I just wrote a book about this called the Bogel Effect. I do think that high cost to low cost is the real trend, because in mutual funds to ETFs, passive to active, there's a lot of gray area there, but high cost to low cost, which I think I give Vanguard and

Bogel a lot of credit for ushering that in. Is like everywhere, and clearly the lower thing cost things get, the more people will use them. I totally agree. I guess my question is, are you sort of saying that the cheaper and easier that things get or access points, the people who come in later, like in a Ponzi scheme are going to get the worst returns than the rich people who were already in here. I understand where your tradition intuition comes from, but it's not exactly what

the model says. So first of all, the model is static, so there's no such thing as early investors and late investors. There's just a comparison bit between. If today you asked investors or you measured whether they would be better off UM without index funds compared to index funds costing zero, the answer would be yes, it would be better off. Okay, So it's a comparison within time. It's sort a comparison over um time. So there's no Ponzi scheme here in

the sense of bubble building. It's just a boring statement about the level of asset prices being higher, so I think. But what I should explain in though, is what what exactly I mean by investors being better off without index funds, or that index funds harm investor welfare. So let me be very clear, for every individual who learns about index funds and ditches holding individual stocks and or active expensive funds and buys cheap index funds, that's good for them,

There's no question about it. That's we explained that very clearly in the paper. It's a very different statement to say investors overall as a group would they be better off and the entire distribution of investors would they be

better off if no index funds were around. So this is like a tragedy of the commons problem, right, So where you have you have a common resource um that gets depleted I don't know whatever fish, atlantic salmon or I don't know what, like not farm raised salmon, and if left to its own devices, um, individual fishermen will buy big, big, big ships and deplete the resource and it'd all be better off if there were restrictions on the side of ships or the size of the fleet.

And it's similar in this case. I'm not saying it's stupid for an individual to buy index funds. Um. I preach um since decades, and I live what I preached by buying index funds myself. But that doesn't mean that overall it's good for investors that they're around. That is really interesting, and I'm glad you admitted that, because that was gonna be one of my questions. I have found a lot of times you you get a lot of attention if you say indexing and passive is going to

be a bubble, or it's a worry. The press will cover you. It's just like any other worry. People who worry get a lot of press coverage. So but when you add, when you actually ask them what do you hold, they'll say index funds, and I'm like, well, then you're part of the problem. Or because here's my big question is let's just say people listening or I agree with this premise, and we all kind of come to the

inclusion that index funds probably should be somehow curbed. Nobody that holds index funds, I can pretty much say them is willing to take one for the team and jump over to a eighty basis points blend active mutual fund for their kids education. They want that money for them. So I think part of the issue is, and this is like to get your take on this, When Vanguard came out in the seventies and they started lowering fees over the next forty five years, Active mutual funds didn't.

They didn't share any economies of scale. And when the world kind of turned and the Internet really spread information and Vanguard got below ten basis points man that caused this frenzy of money to move over to indexing, and it was like Active was so far behind at that point they they just missed it completely and got disrupted by Vanguard big time. And so what you're I think experiencing here is just an industry that that failed to see what was coming and recognized an opportunity. But we

are seeing Active lower their fees. So as Active gets cheaper. In et F last year, they took in fourteen percent of the flows but all went to pretty low us Active. So I think the Vogel effect or Vanguard effect is actually one that could help solve this because Active gets cheaper and more appealing because a lot of people are fans of Active, just not the cost, and so as it gets lower, you might find a little more balance. What do you say about that, like just sort of

let letting the market figure this out. Well, so I agree with um basically everything you said in that Vanguard is a cost leader, a price leader is responsible for the depression of fees, and every single investor is happy about that, right because every single investor has to has to pay these fees. Now, if it leads to active funds also becoming cheaper, well, that leads to more stock

market participation. And as we discussed a few minutes ago, of course it's desirable on many levels because it's going to reduce wealth inequality, right, but it will not solve the problem of the essetprises being high and the return is being low because it doesn't need to more companies producing higher profits for for shareholders. It's just a greater sharehold rebays sharing these profits. And again, if you're if you just want to reduce wealth inequality, I'm all with you.

And that's what the model indeed predicts that index fund's helped reduce wealth inequality and expected wealth, but every single one of the investors is still worse off. They'd be better off with the with the ad basis point mutual fund from the ninety eighties in terms of their risk

return trade off compared to everybody else. Right, So the resolution of the apparent paradox is, yes, nobody is willing to give up their zero percent index fund for an ad basis point active fund, except if everybody else would do it too. And that's a statement, right, So it is not about individuals are being irrational. It is about investors as a group are harming each other by driving

up the asset prices. But they're acting out of their self interest though, which it has everybody excerationally, but it has to be that way. So this expected return, right, is that also just part of the FED, right. The FED and central banks around the world kept rates very low, did qui Asset prices lifted probably beyond what valuations, you know, what earnings would suggest, and it created a little bit of a FED bubble. A lot of people thought this

was the passive bubble. I said, no, it's a FED bubble. And they associated the rise of the last fifteen years with all the index funds. But now that bubble is broken, the FED is hiking. For the past year and a half, people still buying index funds, but the market's going down. Clearly index funds were not enough to wag the dog or anything, and stocks are all over the place. There's plenty of dispersion, so I think the hiking sort of show that the markets acting pretty much as it does.

But I guess my bigger point to you is, is the expected return being low really more of a function of the FED and their policy over the past fifteen years rather than just the rise of index funds? Yeah? Probably yes, so Uh. The paper does not have the addition to try and explain the reasons for declining the expected returns or argue that this is primarily driven driven

by nix fins. The The ambition is really just to understand what the effect of indextend an asset prices is, and I think probably also shift our thinking on how we think about certain policy tradeoffs, such as you know, people thinking that indexing necessarily benefits investors, but then there might be side effects, and maybe to rein in the side effects we would have to harm investors. And this is how the tradeoff and the policy debate gets and

gets characterized. And what this paper shows, um, but the math shows is just that this is probably not the right way of thinking about it, because it's less than perfectly obvious that cheap diversification even benefits investors as a group. Of course, it benefits every individual investor, but it's not

clear that it benefits and as a group. So one thing I think that you're talking about and that I see in the flows and I want to get your take on, is it seems like we're going to move into this new world where passive takes up the core of most portfolios, and then people are going to look for something that's very, very different than passive to sort of decorate with almost like adding a little hot sauce and otherwise boring meal. This is the lane that like

Cathy Wood lives in an arc even crypto um. And I think active managers over time are either gonna have to get cheap or shiny. They're going to have to be really producing some high returns two A attract investors

attention and be get used as a compliment. And so could you argue that over time that active slice will start to produce some really big winners and you will see some money go to those more active active managers, and the net result will be a rooting out of the bad managers giving money to the good ones, um, and you still will have active setting prices. Is there anything wrong with that world. I don't see that there's anything particularly wrong with that world. Nope. I think that's

that's probably a reasonable prediction. But I would have to admit that I have not done a whole lot of research on how enterprises get set when active and passive managers coexist. I find that that distinction I think you alluded to it. I find that distinction not super useful these days. Whereas you know, it qualifies as a passive fund to follow an index that is a bespoke index

just designed to follow a particular portfolio. And so when when I say passive, I really mean, you know, market level indexing like in the textbook, which is different from what passive means in in the real world these days. But just to be clear, I think what has happened because the S and P isn't even passive. I mean there is run by a committee. Um, there's rules, and then you get to other indexes like the Russell one

thousands a little different. I mean, I think really your point is more about just people in funds rather than you know, people buying funds today holding them because they're cheap and good rather than passive and active. Um yeah, I think so, yeah, very much. The true benchmark would be you holding a market value waited portfolio of all the world's risky assets, right, And I think we can all agree that the S and P five is not

that Not even you as equities is that, right. So in theory you have to have exposure to Chinese real estate or I don't know what, right, So this is true passive in the textbook, and anything that's labeled passive

these days is very far removed from that. So for for that reason alone, I don't think a lot of the headline discussion and the public discussion about passive verse effective makes a whole lot of sense, because look, if I build a portfolio of passive funds, but every of these passive funds contains one stock, then this is literally the same thing as active investing. So I don't think that that these labels are as meaningful as they perhaps used to be fifteen years ago. I agree, Um, there's

just too much gray area. I still use it because you have to communicate quickly sometimes, but that's very totally That's why I again I go back to our phrase the great cost migration. Most of this is just high cost low cost. What makes pass passive was ninety basis points, it would be fringe at best. Um, it's because it's free. That's why it's a big deal. Um, let's let's move to to what should be done here? I mean, is there any real solution here or is it just Hey,

there's more people invested. The FED lowered rates for fifteen years. It's created It created a little bit of a of a bubble. And now look, returns are gonna be low for a while because of the you know, sort of a return to the mean, Like you can't escape the mean, so you're gonna have lower turns. Is that generally the take?

Or is there a way to solve this? So I don't think that there is immediate policy implications from this paper, but rather that we should think of it as a stepping stone to towards thinking more accurately about what other policy tradeoff should be about. So, um, you know, I did a bunch of research on how diversified ownership of firms might affect competition, and these policy trade offs look

completely different. Um, once you endotonize, a survises, So what I mean by that is once you take it into account the effect of diversified ownership on asset prices, then if you basically ignored that link. So I don't think the paper itself has a problem that needs to be solved and therefore no policy implications, but I think it informs how we should think about other side effects that

people have debated in passive. So let's talk about one of those, which you wrote about and I covered in my book as well, which is called common ownership, which is very communist, communist side term. That's basically I'll summarize it. You correct me um or clean clean it up at all. Okay,

So common ownership. What this says is that like, hey, if if index funds own, say all of the airlines, or they own all the carmakers, there's a vested interest or a motivation for those all those car companies two raise prices because if you own them all, there's no reason to care about who wins or loses. You want them all just to have higher prices. And that's the danger of having only a few firms, especially diverse. But index funds owned, say of each stock. Is that about right?

That is about right? This is not this is not terribly wrong. But let me point out to two things that we could gain an even more nuanced understanding about. Then perhaps I will also offer you my story of what I think is going on. So the first part is about index funds. The research I did does not single out index funds at all, has really nothing to do with index funds. So we call a common ownership.

But what we mean by that is simply a measure of the extent to which, um, the largest and most influential investors of one firm also hold the competition, whether that's index funds or whether it's Bill Gates family office,

or whether it's Berkshire Headaway. UM. We don't make a distinction in that paper about that, right, And empirically, I'm sure the listeners of this podcast have noticed that Warren Buffett was one of the largest or actually the largest shareholder of whole bunch of airlines until the pandemic hit UM and he's clearly not an index fence, right. So that that is the first piece of nuance that it's really not about index funds at all, but the public

commentary has very much been about it. And then the second nuance is about whether the Carmakers or airlines or what not have an incentive to raise prices once they figure out that their investors are really the same as the investors of the competition, as opposed to whether the managers simply get lazy, but the managers get lazy because they don't get monitored quite as actively as if I don't know, Elon Musk was the largest shareholder of Jeff

bahos Or or Mark Zuckerberg, and therefore simply don't reduce costs quite as effectively as they otherwise wouldn't, right, And that's basically my story. My story is. Look, and I think I would think that you and I probably agree that the governance activities of Vanguard or black Rock do differ in some ways of Elon Musk's governance activities. Yeah, and that those could ostensibly lead to differences and how aggressively management costs costs. That seems kind of obvious too.

That's basically the entire story. All I'm saying is that um I, Vanguard doesn't do anything. I mean, they do something, but if they did absolutely nothing to hold management accountable, then probably this firm's costs would be higher. Well, the firm's costs is the firm's costs are higher than it's going to set higher prices. So that's my story. My

story is, look, index once are probably not the best. UM. You know, activists investors to hold management accountable, and you're going to see that in the firm's productivity and therefore in product prices. Okay, so it's not a giant conspiracy. Go ahead, Yeah, I agree. I agree because UM one quick anecdote here and I just love this story. Eric Posner, who did he? Did you work with Eric Posner of Chicago? I didn't work with him my home very well, but

we we haven't worked together yet. So he also wrote about this, and I um went and when I was researching the Bogel book, I found a video of Jack Bogel in a little Princeton office with Bert Malchiel, Cliff Fastness, Andrew Low of m I t there was like seven or eight heavyweight thinkers in there, and Eric and Jack just wanted to talk this out because it was getting some media attention. This is like six months before he passed away. That's how hardcore Bogel was and how passionate

he was towards this stuff. But I I watched the whole video. They didn't really come to any conclusion. I felt that the passive side one, but I might have been rooting for that side. I don't know. Um, but people should go just google it. It's um on the Princeton website and you can watch it and make up your own mind. But one of the things that was in there was this Gus Souter, who was c i O at the time when Vanguard was getting bigger and bigger.

He was like, we've we do not collude with black Rock. We we're we're honestly trying to vote in a way that's you know, for the benefit of the of the company's long term health. And if you look, they have corporate governance teams that pay attention to this stuff and they do vote differently. Even black Rock differs from Vanguard in certain votes. Um, we've studied it. I would I

would agree it's not aggressive, it's not active. So given that, you know, knowing their voting to try to keep the company honest and do a good job, you still think this common ownership is a problem. Yeah, So, um again, I agree with everything you said. Um. So, the most important part is that none of this this theory that is being discussed here really has anything to do with collusion, actually explicitly not not collusion between firms, not collusion between

different types of shareholders. Whenever an industry representative talks about how they don't collude, that's a complete strong man. None of these series is about collusion. Again, the theory is just about they are probably not as active owners as other investors. So let me tell you a story, and I'm want to get your take on this. Two or three years ago, this small company called Tanger Outlets. I might even be pronouncing it wrong, that's how small this

company was. There was a time when it had fifty five or sixty percent of its shares owned by index funds and ETFs. It's a long story, but this dividend fund owned because that stock was going down and it kicked out a big dividend. But Active was selling off the stock, but Passive liked the yield, so Passive ended up buying it from Active over like two years, and all of a sudden, Passive I called the I R woman and I and I asked her, you know, what, what do you think of this? Like? Is this um? Uh?

She goes, I don't think of it at all. I said, she goes. I will say that the passive owners are a little less engaged. But we're trying to like make payrolls, like we're trying to make money here, We're not really we don't really care who owns us. We are we have bigger fish to fry. So isn't it true that just business and capitalism also just kind of solves this and we don't have to worry about that much? Have

you talked to a Twitter employee lately? I mean, it doesn't It strikes me that the change in ownership that came with Elon Musk buying a large stick in the firm and putting a huge amount of pressure on that thing becoming profitable rather changed the cost cutting incentives um off the CEO or of the firm. No, so, I'm not saying Mega doesn't do anything. I'm saying they do less right, And perhaps a better comparison is um berta had Away. Right, So let's think of Warren Buffett. Warren

Buffett occasionally by his firms and gets engaged in governance. No, so we all immediately think of Coca Cola presumably or American Express. Right, So, Warren Buffet ocation would put himself on the board. Now, let's take the other situation. Warren Buffett by is huge steaks in the three or four largest airlines in the US. Did he put himself on the board as well? And the answer is no, right, so he did not put himself on the board. There he gets less actively engaged UM with companies where he

also buys the competition. And that's exactly what economic theory would predict. You simply don't have an incentive to engage strongly with one company with part of the one company's success comes at the expense of another company that you own as well. So my point as well, there's a reason Vanguard and Black Rock have governance teams, but the governance teams are nowhere close to um, you know, the intensity of the Bill Ackman or you know, any type

of activist investor who's the alternative largest shareholder of the firm. So, yeah, that is something, But is it good enough? Well, I mean it's less right. And if management is held to account less actively UM, then the costs are going to be higher and the price is going to be higher. So that's it. It's a very boring story in some ways. You know, it has nothing to do with collusion, has

nothing to do with evil motives. It just has something to do with incentives to engage in corporate governance and you know costs being a little higher when the shareholders basically let management room free. So with that said, you know, Vanguard and black Rock and Schwab have all announced initial pilot programs to decentralize the share voting so that it's

not so centralized it's just them now. I would say that the individual voters, like the thirty million Vanguard and voters, many may just opt to have Vanguard do it, but many may opt to have a third party to it. Schwab is looking at polling just to get there where their head is at and then vote that way, because I don't think an individual investor. What's the deal with all of these proxy votes? It's really boring and time

consuming and most of them are not really consequential. Um, do you think that decentralized trend could help this at all? I think you just said it right. Um. So, first of all, it's a it's an interesting question, it's a

very interesting question. But if the problem is that Vanguard's governance team with the cloud of all these assets and the associated votes if they don't use that very effectively because they don't have incentives, and now you give it to shareholders that are equally diversified, but having even lower incentive and less expertise to be engaged. It's not clear that this is going to help the problem. Right, So I'm doubtful that this would be a solution to the problem.

But and let's go to the problem one more time. I lam a sniff test guy, you know, and I think that matters. I haven't really seen anything that I can touch or feel that has been a byproduct of this concern. Like, it seems like competitions alive, and I haven't seen one industry where prices just got crazy. I mean, I know inflation went up recently, but that was largely a function of you know, the lockdown and the FED

and whatnot. So have you seen anything specific that is a direct result of this or is it just a little too hard to measure or a little too early to measure? Yeah, So look, that's a that's the crux that theory that I'm pronouncing here that's been around for decades. It was actually a Princeton guy as well, Prince Princeton graduate who came up with that in his first job

at a M I. T Um. And if you try to test that using the time series of our overall price levels higher or lower, you can't get very far right, because there's all these alternative explanations. But the claim to fame of that first paper is that we study differences in particular roots. So say you know, some airlines become more owned by say the black Rocks and bang Ards and perhaps the Berkshire Hathaways over time, so they become

more commonly owned. And in the theory, that would make those and the roots where they compete set higher prices whereas other airlines don't. Right. So there's Richard Branson owning Virgin America and being behind the CEO and cost cutting and going to the media all the time promoting the products and so forth, right, And the test um the proof of the pudding of the theory here was in seeing how say, the Virgin America has compete with the

Deltas in the United's of this world. And what you see very clearly there is that the prices go up when the airlines become more commonly owned, compared to price changes in routs where there's less common ownership, and the common ownership does not go up. Yeah it doesn't. That is where the proof of the pudding is. Yeah, it doesn't. The common ownership self police itself because if you are a common owner of all the airlines, you're also a common owner of, like I don't know, all of the

tech company season all of the industrial companies. And if airline prices go up, then it's gonna hurt business travel, which might just end up hurting a lot of the other sectors that you own. So doesn't higher prices ruin other things? Therefore, you would, as as an index fun owner, not want that because you're you're looking after all the sectors, not just this one. Yeah. I think that's an argument that makes sense in in some cases more so than

in others. Right, So airlines, most of the tickets get sold to the end, to the end consumers and not to other businesses. But you could say, well, what about oil companies. A lot of the airlines cost is oil, So what if you have common ownership between the oil companies and the air line companies. And indeed there's evidence

that this leads to lower prices. So more common ownership between vertically related firms so suppliers and customers actually tends to lower prices, which is one more reason why it's really not about indexing. Right, So the problem for competition is not come from indexing, or at least nobody has shown that it does. The problem with competition comes from the same investors holding horizontal competitors. And what the overall effect on indexing or passive is on competition. Nobody has

even started to properly address that. And that's actually where you know, that first paper we talked about comes in again. You know, when you look at the airlines alone and then just say look and the economy consists of a whole bunch of industries, they become more commonly owned. Let's fix the problem that's prohibit indexing. Well, let does not take into account that there are vertically related firms. It does not take into account that, hey, asset prices might

go up. And here's the thing that was missing from the first paper. When asset prices are up and expected returns are low, well, uh, that actually reduces the cost of capital firms. And wouldn't that be something that potentially makes some expand output, right, And those are things that are simply not present in the economic theories um of the day, and those are just directing limitations one has

to acknowledge when debating these policy proposals. So in the common ownership last question on this, is there a public policy? I know the first one you said, there's really no policy recommendation. Would you have a policy recommendation on the common ownership issue? Is like maybe, um, you can't own more than three or of the industry. I mean, would you before instituting something like that, which would also ultimately make index funds illegal. So that's a good one, right, So, UM,

there are policy proposals. I'm saying I have not myself endorsed any or or made any but in the legal scholarship, the journals are full in the last five years of all the policy proposals that go from anywhere from you know, let's just take all the voting rights away from index funds, or let's say we provide a safe haven for any investor who holds less than one percent of all the firms, um,

and otherwise you know, the antitrust laws apply. So other people have made these proposals, and I have, and basically for the reasons that I just that I just mentioned, Um, there's a whole bunch of open questions that I think have to be addressed. But another reason is there's much more low hanging fruit. Why why do we focus on the black rocks and the vanguards of this world? Why nobody takes any issue with Berkshire Hathaway buying in the

competing airlines. Nobody raises an eyebrow or and this is a that's a literal example, Bill Gates family office buying thirty percent stakes in the publicly traded waste management companies, Like why why do we debate whether Vanguard has an effect on passive? Why we just tolerate that and not even scrutinize it. So I think the there's much more low hanging fruit. And and there's no none of these concerns that we just mentioned about vertically integrated firms and

equilibrium effects and all this good stuff. We don't have to debate that when it's about a particular relatively small investor basically deliberately buying shares and competitors um, then I don't really understand why why we're putting so much attention on the big index funds. So I think there's lower hanging fruit for the policy makers than debate these structural proposals. Uh, yeah,

I know those are good points. Um. And I brought these worries up with Bogel and um one of my interviews with him just before he passed away, and he addressed Eric Posner specifically that you know, you get these worries all of a sudden, they get into the New York Times, and they get written about the wrong way straw man, as you would say, and all of a sudden, you know, he specifically mentioned Elizabeth Warren sees it as something she can run on because it's like her versus

the big guys, and all of a sudden, bam, you just ruined this golden goose for small investors, which is a cheap index fund. And that's the worry of the some worry articles. So so look, I'm laughing because this is where the circle closes. And that makes me a little happy. Right. The policy trade of as it is illustrated, is being thought of as diversification is good for the small investors. But if we inter emed, then we would

take that away from them. And that's what's so important about the first paper, the first paper which says, wait, it's actually much less obvious than we thought whether cheap indexing is actually good for small investors. All right, So my point is I think that first paper doesn't have policy implications on its own, but it does make you think differently about the policy trade offs that are to be considered when it goes when we're talking about these

other side effects, like the effects on competition. There's a lot of layers to this. You own passive, right, This is where I really like, I just want to close

with this. What what what would you need to see to make you take one for the team and move over to a high cost or a higher cost active fund or something different with your money, because I think that's sort of what other people would need to see because if you, who looks right at this closest, is still in index funds, it's gonna take a whole lot more to convince anyone else to leave. No. So, um, yeah, you're not gonna get me to divest from passive until

you make it expensive. Now, So that's what regulation is for. Look, I'll tell you a story of little Martin being in the grocery store when I was I don't know, seven years old, and my mom showed me how the flowers were flown in from I don't know, South America or Africa or I don't know where, and how that bad was that for the climate, and therefore we should just

shun that and not buy these products and so forth. Look, what I see is that despite these effects, these efforts by my mom um to get people to not buy what is attractive to them, somehow they took over and flowers are still being grown and flown around the globe. Perhaps that's bad for the for the climate. But it's not the job of individual consumers to fix that. That's the job of policy makers. So you know, that's a

broader point. But the entire structure of the problem that I'm talking about is that for individual investors, it is perfectly rational to keep buying passive funds. And that's what I do, because you know, I try to be a rational person most of the time. But that doesn't mean

that it's good for you know, societies. And that's what the role of the role of policymakers is, which is why you know, I see it so critically or with so much concern when politicians lean back and go like, look, let's just hand over world world government to you know, the big asset managers. Surely they care about the world just as much as you know people do. And so I think that's just faulty logic. That is literally the role that politicians are supposed to play in an economic system,

and not the investors. So I don't think the investors are to blame, nor should they change anything. The ball is in the court of the politicians here. Okay, So let's say the politicians said they reversed the Vanguard effect from forty five years and said index funds can exist, but they can be no cheaper than ninety basis points. How would you as an individual investor that hold index funds,

feels like, what would your reaction to that be. I mean, look, I'm kind of rich, so I would probably still hold funds and make way higher returns, So I'd probably benefit from that policy, and you're probably among that camp as well. But well, I would feel bummed because I've looked at the numbers. If you pay even one percent more over fifty years of compounding, we're talking hundreds of thousands of

dollars that go to the industry and not you. It adds up over time, and so even ninety basis points or a hundred and fifty even ten over enough time can be a lot of dollars and cents. And I think that's where if you're an individual investor who's looked at those charts, you'd be like, wow, what a bummer. Absolutely so look, um, we were on the same page on that. I just started a bunch of college savings accounts for my kids, and in Europe you do not

get excess necessarily to these fantastically cheap index products. I got one for what like ad basis points from some local German bank and it makes me amazingly upset. It's basically a rip off, and I'm very upset at that. I get even more upset when I think about how many millions of German savers there are UM that are being ripped off without understanding that it could be so much cheaper. We're totally on the same page about that.

But the reason for that is because um, here's a few UM you know that's called it less sophisticated or more heavily regulated UM investors that don't have access to the cheap funds, but they still suffer from the lower expected returns. So this is where the that's where the trucks comes in. Of course, everybody agrees that cheaper funds are better than more expensive funds at the same time, but if nobody else was able to invest um at such low costs, and therefore asset prices would be lower,

I think a lot of people would be happy. You know, it's the same thing about houses, right, So I mean, go in the street and talk to a twenty five year old about whether they are happy or unhappy about high house prices. Look, I mean, it's it's kind of obvious that we're unhappy about that. That we spend a greater fraction of our savings on assets that have a particular dollar return. If we have to pay more for it,

we're clearly worse off. Right, So if you told them, hey, let's um institute a reform that makes housing prices lower, surely they would be happy about that, even though in the face of it you can't immediately see it because made you think about the fee that you're paying, but you don't immediately understand that the equilibrium effect would be that the prices are lower and you you get to benefit from higher returns. All right, Well, Martin, we have

a fun way of closing the show. Um, we ask everybody on here, what is your favorite e t F ticker. It's VT the Vanguard Total World, which is a that's total World stock index, fundily tax book indexing. That's what I do. Nice that is that is as close to pass of as you can get with an et F. So that's it. Beautiful irony here that that that's your favorite figure. It is good place to end anyway, Martin, thank you for joining us on Trillions. Thank you very

much for the opportunity. Thanks for listening to Trillions until next time. You can find us on the Bloomberg terminals, Bloomberg dot com, Apple Podcast, Spotify, and wherever else you like to listen. We'd love to hear from you. We're on Twitter. I'm at Joel Weaper Show. He's at Eric Caltuness. This episode of Trillions was produced by Magnus Hendrickson. Bye