By the end of 2020, almost $16 trillion was in various forms of index funds. The remarkable growth of passive investing is the subject of a new book by Financial Times reporter Robin Wigglesworth, “Trillions: How a Band of Wall Street Renegades Invented the Index Fund and Changed Finance Forever.” In it, Wigglesworth looks at how the birth of the first index fund in 1971 gave way to today’s trillion-dollar business.
Click the audio player to hear Wigglesworth’s conversation with “Marketplace” host Kai Ryssdal. The following is an excerpt from the book.
The biggest equity fund in the world is now an index fund. The biggest bond fund is as well. The leading gold index fund now holds more of the yellow metal than most central banks, an astonishing eleven hundred tons. That is equivalent to a quarter of all the bullion in Fort Knox. No wonder that Bloomberg’s podcast on a form of index funds known as exchange-traded funds (ETFs) is called “Trillions,” a tongue-in-cheek reference to Billions, Showtime’s series on the fictional hedge fund manager Bobby Axelrod.
The boons are being reaped by nearly everyone, directly or indirectly. Paul Volcker, the former chair of the Federal Reserve, famously said in 2009 that the only valuable innovation the finance industry has conjured up in the past twenty years was the ATM. Broaden that to the past fifty years, and I would argue that the index fund — first born in the early 1970s — is up there. The average cost of mutual funds in the United States has halved over the past two decades, largely thanks to the growth of index funds and the pressures they bring to all investment fees.
The net savings over that period amount to trillions of dollars, money that goes straight into the pockets of savers, rather than highly paid finance industry professionals. For example, the overall annual cost to investors of the entire $8 trillion universe of ETFs — a next-generation version of index funds that will be explored in later chapters — is, roughly speaking, $15 billion. That is way less than just Fidelity’s revenues in 2020, and a tiny fraction of the hedge fund industry’s total earnings.
The finance industry has historically been adept at inventing new products that line its own pockets more than those of Main Street. The index fund is a rare exception to the rule. At a time when the gap between the haves and have-nots is widening everywhere, the positive impact that an initially much-maligned invention by a motley group of self-described finance industry renegades and heretics can have in the space of a few decades is inspirational. Nonetheless, new technologies — and that is essentially what the index fund is — always have side effects, and not all of them are positive. As index investing has grown, the initially snide comments have been replaced by concern, even fear. Over the past decade, it has become a crescendo. Paul Singer, a famous hedge fund manager, even argues that passive investing has grown into a “blob” that is now “in danger of devouring capitalism.”
“We are always amazed by decent ideas and insights which are stretched so far beyond their original version that they become caricatures of themselves and then sometimes contra-functional. So it may be with passive investing,” the head of Elliott Management wrote in a letter to his investors in 2017.
Singer is hardly a dispassionate observer. Index funds make his life harder, both by pressuring the eye-watering fees that the hedge fund industry has historically charged and by making the corporate crusades Elliott is famous for a lot more complicated. Nonetheless, his criticism, although shrill, has a kernel of truth to it.
For proponents of index investing, it is important to recognize the potentially negative implications and try to ameliorate them, rather than blindly deny that they exist. The growth of passive investing will prove one of the most consequential challenges that we face in the coming decades, not just to markets and investing but to the way capitalism functions. That may seem overblown, especially at a time of pandemics, resurgent nationalism, and widening inequality. But as we saw in 2008, whether we like it or not, finance touches every aspect of our society in ways that are often hard to fathom.
From “Trillions: How a Band of Wall Street Renegades Invented the Index Fund and Changed Finance Forever” by Robin Wigglesworth. Copyright © 2021 by Robin Wigglesworth. Published by Portfolio, a division of Penguin Group and Penguin Random House. Printed by permission.