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Speaker 1: Welcome to a Trilliance. I'm Joel Wepper and I'm Eric

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Speaker 1: call Tunics. So Eric and all of our time together,

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Speaker 1: I think I've missed only a couple interviews and this

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Speaker 1: was one of them, which I'm bummed about because you

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Speaker 1: went into a research territory and uh and and talk

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Speaker 1: to somebody about UM indexing. And I always like to

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Speaker 1: know more about this space because it's not maybe directly

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Speaker 1: linked to sort of takeaway investment advice, but it informs

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Speaker 1: how e t f s are structured and how investors

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Speaker 1: might need to think about the space overall. So joining us, um,

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Speaker 1: Joining you on this episode of Trilliance was Martin Schmalls,

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Speaker 1: who's a professor at the University of Oxford's Business School

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Speaker 1: where he teaches finance and economics. He recently wrote a paper.

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Speaker 1: CO wrote a paper index funds, asset prices and the

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Speaker 1: Welfare of Investors. Why did you want to talk to him? Yeah, UM,

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Speaker 1: passive is growing. Ets taken all this money, index fense

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Speaker 1: taken all this money, and people like to study them. Um.

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Speaker 1: People have been commenting on the rise of passive in

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Speaker 1: the worries. You know, it's a whole chapter in my

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Speaker 1: vocal book. Some worry and there's been all these worries

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Speaker 1: and UM, this particular person I've met over Twitter and

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Speaker 1: we've debated a little bit. Nice guy, UM, really smart.

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Speaker 1: I think between the two of us, he brings up

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Speaker 1: our average i Q about fifteen points. As you can

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Speaker 1: see from his credentials, he knows what he's doing and

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Speaker 1: he's studied in his latest paper, the idea that index

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Speaker 1: funds might even be too good for their own good

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Speaker 1: because they're so good and cheap. They're basically allowing more

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Speaker 1: people to come into the market and that is going

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Speaker 1: to decrease expected returns in the future, which UM is

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Speaker 1: to the it doesn't benefit anybody going forward. It's sort

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Speaker 1: of like bad for the common good. And this is

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Speaker 1: one of a couple other common good arguments UM that

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Speaker 1: have been made by academics. So we also discussed common ownership,

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Speaker 1: which is another one which we'll go into. I won't

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Speaker 1: you know ruin it now, but basically, if you are

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Speaker 1: an next funder passive owner, UM, you know what what

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Speaker 1: is happening with your money? Like, what are the larger

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Speaker 1: ripple effects and implications? Is there anything to worry about?

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Speaker 1: Do we need public policy on this and that's what

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Speaker 1: we explored, and we covered a lot. You know, I

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Speaker 1: know you weren't here, but we I must have asked

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Speaker 1: them twenty questions. We delved into it and the deep weeds.

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Speaker 1: This is probably why you're needed on this show, because

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Speaker 1: I don't think we would have got as deep maybe

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Speaker 1: for this episode. It was a good thing though, because

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Speaker 1: we really nerded out. But I will say he was

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Speaker 1: real good about being short with his answers so he

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Speaker 1: doesn't go on and on. It's a it's a nice

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Speaker 1: back and forth about several of these sort of concerns

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Speaker 1: over the rise of index funds and passive. I think

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Speaker 1: you'll enjoy it, especially if you're anybody at all interested

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Speaker 1: in how markets work. Is famine Trillians Martin Schmall's alright,

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Speaker 1: So Martin, welcome to the show. We've never met in person.

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Speaker 1: We've interacted on Twitter here and there, and I've gotten

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Speaker 1: to know you a bit over the years through digitally,

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Speaker 1: I guess. So it's nice to have you on and

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Speaker 1: finally meet you. And I think we have the you know,

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Speaker 1: pretty nice civil debates on this, as I do with

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Speaker 1: many other people. This concept of passive is a is

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Speaker 1: a concept that is studied, because it's getting bigger and bigger.

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Speaker 1: As you know, I tend to write off most of

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Speaker 1: the worries. A lot of them come from active managers.

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Speaker 1: You're an academic, so I think that gives you some

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Speaker 1: objectivity that I would give you a little more attention.

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Speaker 1: There's a couple issues we're going to bring up. Let's

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Speaker 1: go over your latest paper, though, just give me the

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Speaker 1: what's it called? Like, what is this sort of thesis called?

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Speaker 1: And what is it? What is the worry here that

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Speaker 1: you're looking at UM? So the papers called index funds,

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Speaker 1: as at prices and the welfare off investors. And I

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Speaker 1: wouldn't say that we're looking at a particular warrior. We

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Speaker 1: didn't start with the warrior. We started with a question,

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Speaker 1: and the question is simply how indexing textbook indexing, you know,

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Speaker 1: holding the market portfolio UM would affect the level of

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Speaker 1: S prices and how that would affect investor welfare. So

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Speaker 1: that's what we started out with. And I suppose one

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Speaker 1: could say that it leads to a warrior. I would

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Speaker 1: just call it a result, which is that it raises

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Speaker 1: a surprices the level of a survices and thereby reduces

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Speaker 1: expected returns. That's the baseline of the finding. So Matt Levine,

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Speaker 1: who's got away with words, who many people know rich

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Speaker 1: for Bloomer opinion. Here's how he put it. An index

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Speaker 1: fund is a good way to hold stocks. It has

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Speaker 1: low fees and offers their versification. Therefore, if index funds

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Speaker 1: are easy and cheap, more people will invest in the

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Speaker 1: stock market. Then if there were no index funds, this

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Speaker 1: will push up the price of stocks, pushing down their

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Speaker 1: expected returns, and therefore index funds are bad for investors.

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Speaker 1: So that is exactly accurate. Um, I think pretty much

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Speaker 1: every step of the way here should be obvious and

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Speaker 1: mostly un arguable, except the last. Perhaps the last one

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Speaker 1: at least was not obvious to me, and it's still

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Speaker 1: not to present obvious to me. That is just what

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Speaker 1: the computer simulations spit out. So bad for investors in

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Speaker 1: this case means reducing welfare of investors. That's a welfare

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Speaker 1: part in the title. So I totally agree with the

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Speaker 1: characterization of Matt Levin that the product. Well, let me

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Speaker 1: ask you this, then, is this really an index fund issue?

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Speaker 1: Mutual funds were introduced a hundred years ago. You could

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Speaker 1: argue they brought in a ton of investors, and up

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Speaker 1: until the late nineties of active mutual fund assets or

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Speaker 1: mutual fund assets was an active funds. So was that

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Speaker 1: a similar issue? Then, like why is it index funds

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Speaker 1: and not mutual funds in general? So this is fair

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Speaker 1: what you're asking here, and um, there's no distinction in

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Speaker 1: the model between an active fund or UM an index fund.

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Speaker 1: In fact, there are no active funds in the model.

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Speaker 1: The only thing that matters is whether it has become

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Speaker 1: cheaper to hold a diversified portfolio. And that's obviously what

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Speaker 1: index funds do, and much more successfully than active funds,

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Speaker 1: which is you know why I hold inext funds. So

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Speaker 1: if active funds had similarly brought down the cost of

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Speaker 1: holding a diversified portfolio, they would also riise UM and

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Speaker 1: enterprises and thereby reduced returns and as a result of

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Speaker 1: reduced investment welfare. So in some ways it's really about financialization. Um,

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Speaker 1: then about index fense. I think that's fair. So I

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Speaker 1: guess we already concluded that it's not about passive versus

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Speaker 1: active as much as much of the debate about passive

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Speaker 1: investing really is. So a natural reaction to this would

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Speaker 1: be well, some people argue not enough people are invested,

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Speaker 1: like here in America only fifty of the population has

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Speaker 1: any exposure to stocks and bonds, right, And this is

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Speaker 1: added to the wealth gap because you know, you're getting

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Speaker 1: that equity market premium and the income from bonds. And

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Speaker 1: so as someone who replied to me on Twitter at

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Speaker 1: economic he said this, why is it better for people

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Speaker 1: to be investors in steef twelve percent return then for

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Speaker 1: fifty people to be investors and receive eight percent return?

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Speaker 1: I would almost go further and say, well, what about

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Speaker 1: a percent investors? Like I guess your thesis almost seems

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Speaker 1: like you're rooting for only some people to be invested.

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Speaker 1: That's that's a really that's a brilliant question. This is

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Speaker 1: really really good. Where do we start? So, first of all,

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Speaker 1: it is true that without cheap index funds, you would

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Speaker 1: mostly get the very rich and least risk averse people

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Speaker 1: to hold the equities, and they would get them for cheap, right,

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Speaker 1: because the returns are high because nobody else is buying them,

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Speaker 1: And indeed that would lead to a widening of wealth

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Speaker 1: and equality. And that is true in the model as well.

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Speaker 1: And as you make holding a diversified portfolio cheaper, say

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Speaker 1: by the introduction of an index fund, say, um, more

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Speaker 1: people invest, And you're exactly right that this actually reduces

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Speaker 1: the difference between the expected well of the very rich

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Speaker 1: and the middle class. It reduces wealth inequality. So what

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Speaker 1: I thought the intuition was going to be of this

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Speaker 1: model is that the very rich get harmed by the

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Speaker 1: introduction of index funds, but the middle class and you know,

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Speaker 1: the poor would actually benefit. But it just turns out

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Speaker 1: that this is not the case. It just turns out

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Speaker 1: that the middle class had held a much smaller fraction

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Speaker 1: of stocks to start with. They also get hurt, and

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Speaker 1: get hurt enough by the reduction, and they expected returns

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Speaker 1: that on net, they don't actually benefit. And that's a

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Speaker 1: surprising part of the result. I'm not sure I like it,

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Speaker 1: but that's what the math says. Are you sort of

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Speaker 1: saying that index funds or mutual funds in general, especially

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Speaker 1: as they get cheaper and cheaper, which again I just

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Speaker 1: wrote a book about this called the Bogel Effect. I

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Speaker 1: do think that high cost to low cost is the

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Speaker 1: real trend, because in mutual funds to ETFs, passive to active,

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Speaker 1: there's a lot of gray area there, but high cost

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Speaker 1: to low cost, which I think I give Vanguard and

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Speaker 1: Bogel a lot of credit for ushering that in. Is

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Speaker 1: like everywhere, and clearly the lower thing cost things get,

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Speaker 1: the more people will use them. I totally agree. I

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Speaker 1: guess my question is, are you sort of saying that

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Speaker 1: the cheaper and easier that things get or access points,

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Speaker 1: the people who come in later, like in a Ponzi

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Speaker 1: scheme are going to get the worst returns than the

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Speaker 1: rich people who were already in here. I understand where

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Speaker 1: your tradition intuition comes from, but it's not exactly what

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Speaker 1: the model says. So first of all, the model is static,

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Speaker 1: so there's no such thing as early investors and late investors.

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Speaker 1: There's just a comparison bit between. If today you asked

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Speaker 1: investors or you measured whether they would be better off

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Speaker 1: UM without index funds compared to index funds costing zero,

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Speaker 1: the answer would be yes, it would be better off. Okay,

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Speaker 1: So it's a comparison within time. It's sort a comparison

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Speaker 1: over um time. So there's no Ponzi scheme here in

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Speaker 1: the sense of bubble building. It's just a boring statement

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Speaker 1: about the level of asset prices being higher, so I think.

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Speaker 1: But what I should explain in though, is what what

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Speaker 1: exactly I mean by investors being better off without index funds,

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Speaker 1: or that index funds harm investor welfare. So let me

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Speaker 1: be very clear, for every individual who learns about index

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Speaker 1: funds and ditches holding individual stocks and or active expensive

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Speaker 1: funds and buys cheap index funds, that's good for them,

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Speaker 1: There's no question about it. That's we explained that very

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Speaker 1: clearly in the paper. It's a very different statement to

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Speaker 1: say investors overall as a group would they be better

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Speaker 1: off and the entire distribution of investors would they be

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Speaker 1: better off if no index funds were around. So this

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Speaker 1: is like a tragedy of the commons problem, right, So

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Speaker 1: where you have you have a common resource um that

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Speaker 1: gets depleted I don't know whatever fish, atlantic salmon or

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Speaker 1: I don't know what, like not farm raised salmon, and

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Speaker 1: if left to its own devices, um, individual fishermen will

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Speaker 1: buy big, big, big ships and deplete the resource and

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Speaker 1: it'd all be better off if there were restrictions on

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Speaker 1: the side of ships or the size of the fleet.

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Speaker 1: And it's similar in this case. I'm not saying it's

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Speaker 1: stupid for an individual to buy index funds. Um. I

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Speaker 1: preach um since decades, and I live what I preached

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Speaker 1: by buying index funds myself. But that doesn't mean that

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Speaker 1: overall it's good for investors that they're around. That is

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Speaker 1: really interesting, and I'm glad you admitted that, because that

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Speaker 1: was gonna be one of my questions. I have found

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Speaker 1: a lot of times you you get a lot of

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Speaker 1: attention if you say indexing and passive is going to

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Speaker 1: be a bubble, or it's a worry. The press will

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Speaker 1: cover you. It's just like any other worry. People who

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Speaker 1: worry get a lot of press coverage. So but when

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Speaker 1: you add, when you actually ask them what do you hold,

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Speaker 1: they'll say index funds, and I'm like, well, then you're

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Speaker 1: part of the problem. Or because here's my big question

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Speaker 1: is let's just say people listening or I agree with

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Speaker 1: this premise, and we all kind of come to the

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Speaker 1: inclusion that index funds probably should be somehow curbed. Nobody

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Speaker 1: that holds index funds, I can pretty much say them

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Speaker 1: is willing to take one for the team and jump

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Speaker 1: over to a eighty basis points blend active mutual fund

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Speaker 1: for their kids education. They want that money for them.

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Speaker 1: So I think part of the issue is, and this

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Speaker 1: is like to get your take on this, When Vanguard

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Speaker 1: came out in the seventies and they started lowering fees

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Speaker 1: over the next forty five years, Active mutual funds didn't.

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Speaker 1: They didn't share any economies of scale. And when the

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Speaker 1: world kind of turned and the Internet really spread information

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Speaker 1: and Vanguard got below ten basis points man that caused

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Speaker 1: this frenzy of money to move over to indexing, and

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Speaker 1: it was like Active was so far behind at that

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Speaker 1: point they they just missed it completely and got disrupted

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Speaker 1: by Vanguard big time. And so what you're I think

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Speaker 1: experiencing here is just an industry that that failed to

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Speaker 1: see what was coming and recognized an opportunity. But we

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Speaker 1: are seeing Active lower their fees. So as Active gets cheaper.

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Speaker 1: In et F last year, they took in fourteen percent

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Speaker 1: of the flows but all went to pretty low us Active.

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Speaker 1: So I think the Vogel effect or Vanguard effect is

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Speaker 1: actually one that could help solve this because Active gets

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Speaker 1: cheaper and more appealing because a lot of people are

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Speaker 1: fans of Active, just not the cost, and so as

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Speaker 1: it gets lower, you might find a little more balance.

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Speaker 1: What do you say about that, like just sort of

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Speaker 1: let letting the market figure this out. Well, so I

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Speaker 1: agree with um basically everything you said in that Vanguard

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Speaker 1: is a cost leader, a price leader is responsible for

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Speaker 1: the depression of fees, and every single investor is happy

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Speaker 1: about that, right because every single investor has to has

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Speaker 1: to pay these fees. Now, if it leads to active

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Speaker 1: funds also becoming cheaper, well, that leads to more stock

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Speaker 1: market participation. And as we discussed a few minutes ago,

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Speaker 1: of course it's desirable on many levels because it's going

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Speaker 1: to reduce wealth inequality, right, but it will not solve

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Speaker 1: the problem of the essetprises being high and the return

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Speaker 1: is being low because it doesn't need to more companies

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Speaker 1: producing higher profits for for shareholders. It's just a greater

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Speaker 1: sharehold rebays sharing these profits. And again, if you're if

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Speaker 1: you just want to reduce wealth inequality, I'm all with you.

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Speaker 1: And that's what the model indeed predicts that index fund's

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Speaker 1: helped reduce wealth inequality and expected wealth, but every single

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Speaker 1: one of the investors is still worse off. They'd be

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Speaker 1: better off with the with the ad basis point mutual

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Speaker 1: fund from the ninety eighties in terms of their risk

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Speaker 1: return trade off compared to everybody else. Right, So the

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Speaker 1: resolution of the apparent paradox is, yes, nobody is willing

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Speaker 1: to give up their zero percent index fund for an

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Speaker 1: ad basis point active fund, except if everybody else would

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Speaker 1: do it too. And that's a statement, right, So it

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Speaker 1: is not about individuals are being irrational. It is about

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Speaker 1: investors as a group are harming each other by driving

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Speaker 1: up the asset prices. But they're acting out of their

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Speaker 1: self interest though, which it has everybody excerationally, but it

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Speaker 1: has to be that way. So this expected return, right,

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Speaker 1: is that also just part of the FED, right. The

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Speaker 1: FED and central banks around the world kept rates very low,

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Speaker 1: did qui Asset prices lifted probably beyond what valuations, you know,

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Speaker 1: what earnings would suggest, and it created a little bit

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Speaker 1: of a FED bubble. A lot of people thought this

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Speaker 1: was the passive bubble. I said, no, it's a FED bubble.

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Speaker 1: And they associated the rise of the last fifteen years

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Speaker 1: with all the index funds. But now that bubble is broken,

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Speaker 1: the FED is hiking. For the past year and a half,

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Speaker 1: people still buying index funds, but the market's going down.

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Speaker 1: Clearly index funds were not enough to wag the dog

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Speaker 1: or anything, and stocks are all over the place. There's

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Speaker 1: plenty of dispersion, so I think the hiking sort of

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Speaker 1: show that the markets acting pretty much as it does.

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Speaker 1: But I guess my bigger point to you is, is

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Speaker 1: the expected return being low really more of a function

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Speaker 1: of the FED and their policy over the past fifteen

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Speaker 1: years rather than just the rise of index funds? Yeah?

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Speaker 1: Probably yes, so Uh. The paper does not have the

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Speaker 1: addition to try and explain the reasons for declining the

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Speaker 1: expected returns or argue that this is primarily driven driven

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Speaker 1: by nix fins. The The ambition is really just to

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Speaker 1: understand what the effect of indextend an asset prices is,

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Speaker 1: and I think probably also shift our thinking on how

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Speaker 1: we think about certain policy tradeoffs, such as you know,

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Speaker 1: people thinking that indexing necessarily benefits investors, but then there

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Speaker 1: might be side effects, and maybe to rein in the

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Speaker 1: side effects we would have to harm investors. And this

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Speaker 1: is how the tradeoff and the policy debate gets and

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Speaker 1: gets characterized. And what this paper shows, um, but the

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Speaker 1: math shows is just that this is probably not the

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Speaker 1: right way of thinking about it, because it's less than

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Speaker 1: perfectly obvious that cheap diversification even benefits investors as a group.

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Speaker 1: Of course, it benefits every individual investor, but it's not

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Speaker 1: clear that it benefits and as a group. So one

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Speaker 1: thing I think that you're talking about and that I

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Speaker 1: see in the flows and I want to get your

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Speaker 1: take on, is it seems like we're going to move

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Speaker 1: into this new world where passive takes up the core

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Speaker 1: of most portfolios, and then people are going to look

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Speaker 1: for something that's very, very different than passive to sort

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Speaker 1: of decorate with almost like adding a little hot sauce

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Speaker 1: and otherwise boring meal. This is the lane that like

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Speaker 1: Cathy Wood lives in an arc even crypto um. And

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Speaker 1: I think active managers over time are either gonna have

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Speaker 1: to get cheap or shiny. They're going to have to

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Speaker 1: be really producing some high returns two A attract investors

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Speaker 1: attention and be get used as a compliment. And so

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Speaker 1: could you argue that over time that active slice will

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Speaker 1: start to produce some really big winners and you will

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Speaker 1: see some money go to those more active active managers,

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Speaker 1: and the net result will be a rooting out of

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Speaker 1: the bad managers giving money to the good ones, um,

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Speaker 1: and you still will have active setting prices. Is there

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Speaker 1: anything wrong with that world. I don't see that there's

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Speaker 1: anything particularly wrong with that world. Nope. I think that's

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Speaker 1: that's probably a reasonable prediction. But I would have to

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Speaker 1: admit that I have not done a whole lot of

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Speaker 1: research on how enterprises get set when active and passive

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Speaker 1: managers coexist. I find that that distinction I think you

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Speaker 1: alluded to it. I find that distinction not super useful

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Speaker 1: these days. Whereas you know, it qualifies as a passive

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Speaker 1: fund to follow an index that is a bespoke index

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Speaker 1: just designed to follow a particular portfolio. And so when

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Speaker 1: when I say passive, I really mean, you know, market

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Speaker 1: level indexing like in the textbook, which is different from

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Speaker 1: what passive means in in the real world these days.

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Speaker 1: But just to be clear, I think what has happened

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Speaker 1: because the S and P isn't even passive. I mean

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Speaker 1: there is run by a committee. Um, there's rules, and

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Speaker 1: then you get to other indexes like the Russell one

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Speaker 1: thousands a little different. I mean, I think really your

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Speaker 1: point is more about just people in funds rather than

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Speaker 1: you know, people buying funds today holding them because they're

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Speaker 1: cheap and good rather than passive and active. Um yeah,

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Speaker 1: I think so, yeah, very much. The true benchmark would

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Speaker 1: be you holding a market value waited portfolio of all

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Speaker 1: the world's risky assets, right, And I think we can

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Speaker 1: all agree that the S and P five is not

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Speaker 1: that Not even you as equities is that, right. So

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Speaker 1: in theory you have to have exposure to Chinese real

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Speaker 1: estate or I don't know what, right, So this is

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Speaker 1: true passive in the textbook, and anything that's labeled passive

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Speaker 1: these days is very far removed from that. So for

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Speaker 1: for that reason alone, I don't think a lot of

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Speaker 1: the headline discussion and the public discussion about passive verse

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Speaker 1: effective makes a whole lot of sense, because look, if

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Speaker 1: I build a portfolio of passive funds, but every of

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Speaker 1: these passive funds contains one stock, then this is literally

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Speaker 1: the same thing as active investing. So I don't think

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Speaker 1: that that these labels are as meaningful as they perhaps

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Speaker 1: used to be fifteen years ago. I agree, Um, there's

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Speaker 1: just too much gray area. I still use it because

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Speaker 1: you have to communicate quickly sometimes, but that's very totally

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Speaker 1: That's why I again I go back to our phrase

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Speaker 1: the great cost migration. Most of this is just high

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Speaker 1: cost low cost. What makes pass passive was ninety basis points,

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Speaker 1: it would be fringe at best. Um, it's because it's free.

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Speaker 1: That's why it's a big deal. Um, let's let's move

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Speaker 1: to to what should be done here? I mean, is

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Speaker 1: there any real solution here or is it just Hey,

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Speaker 1: there's more people invested. The FED lowered rates for fifteen years.

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Speaker 1: It's created It created a little bit of a of

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Speaker 1: a bubble. And now look, returns are gonna be low

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Speaker 1: for a while because of the you know, sort of

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Speaker 1: a return to the mean, Like you can't escape the mean,

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Speaker 1: so you're gonna have lower turns. Is that generally the take?

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Speaker 1: Or is there a way to solve this? So I

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Speaker 1: don't think that there is immediate policy implications from this paper,

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Speaker 1: but rather that we should think of it as a

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Speaker 1: stepping stone to towards thinking more accurately about what other

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Speaker 1: policy tradeoff should be about. So, um, you know, I

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Speaker 1: did a bunch of research on how diversified ownership of

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Speaker 1: firms might affect competition, and these policy trade offs look

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Speaker 1: completely different. Um, once you endotonize, a survises, So what

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Speaker 1: I mean by that is once you take it into

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Speaker 1: account the effect of diversified ownership on asset prices, then

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Speaker 1: if you basically ignored that link. So I don't think

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Speaker 1: the paper itself has a problem that needs to be

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Speaker 1: solved and therefore no policy implications, but I think it

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Speaker 1: informs how we should think about other side effects that

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Speaker 1: people have debated in passive. So let's talk about one

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Speaker 1: of those, which you wrote about and I covered in

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Speaker 1: my book as well, which is called common ownership, which

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Speaker 1: is very communist, communist side term. That's basically I'll summarize it.

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Speaker 1: You correct me um or clean clean it up at all. Okay,

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Speaker 1: So common ownership. What this says is that like, hey,

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Speaker 1: if if index funds own, say all of the airlines,

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Speaker 1: or they own all the carmakers, there's a vested interest

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Speaker 1: or a motivation for those all those car companies two

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Speaker 1: raise prices because if you own them all, there's no

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Speaker 1: reason to care about who wins or loses. You want

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Speaker 1: them all just to have higher prices. And that's the

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Speaker 1: danger of having only a few firms, especially diverse. But

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Speaker 1: index funds owned, say of each stock. Is that about right?

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Speaker 1: That is about right? This is not this is not

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Speaker 1: terribly wrong. But let me point out to two things

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Speaker 1: that we could gain an even more nuanced understanding about.

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Speaker 1: Then perhaps I will also offer you my story of

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Speaker 1: what I think is going on. So the first part

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Speaker 1: is about index funds. The research I did does not

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Speaker 1: single out index funds at all, has really nothing to

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Speaker 1: do with index funds. So we call a common ownership.

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Speaker 1: But what we mean by that is simply a measure

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Speaker 1: of the extent to which, um, the largest and most

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Speaker 1: influential investors of one firm also hold the competition, whether

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Speaker 1: that's index funds or whether it's Bill Gates family office,

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Speaker 1: or whether it's Berkshire Headaway. UM. We don't make a

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Speaker 1: distinction in that paper about that, right, And empirically, I'm

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Speaker 1: sure the listeners of this podcast have noticed that Warren

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Speaker 1: Buffett was one of the largest or actually the largest

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Speaker 1: shareholder of whole bunch of airlines until the pandemic hit

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Speaker 1: UM and he's clearly not an index fence, right. So

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Speaker 1: that that is the first piece of nuance that it's

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Speaker 1: really not about index funds at all, but the public

431
00:23:10,720 --> 00:23:13,000
Speaker 1: commentary has very much been about it. And then the

432
00:23:13,080 --> 00:23:16,520
Speaker 1: second nuance is about whether the Carmakers or airlines or

433
00:23:16,560 --> 00:23:19,000
Speaker 1: what not have an incentive to raise prices once they

434
00:23:19,040 --> 00:23:22,359
Speaker 1: figure out that their investors are really the same as

435
00:23:22,359 --> 00:23:25,159
Speaker 1: the investors of the competition, as opposed to whether the

436
00:23:25,200 --> 00:23:28,520
Speaker 1: managers simply get lazy, but the managers get lazy because

437
00:23:28,520 --> 00:23:32,119
Speaker 1: they don't get monitored quite as actively as if I

438
00:23:32,160 --> 00:23:35,160
Speaker 1: don't know, Elon Musk was the largest shareholder of Jeff

439
00:23:35,200 --> 00:23:39,560
Speaker 1: bahos Or or Mark Zuckerberg, and therefore simply don't reduce

440
00:23:39,680 --> 00:23:43,200
Speaker 1: costs quite as effectively as they otherwise wouldn't, right, And

441
00:23:43,280 --> 00:23:47,240
Speaker 1: that's basically my story. My story is. Look, and I

442
00:23:47,320 --> 00:23:51,160
Speaker 1: think I would think that you and I probably agree

443
00:23:51,760 --> 00:23:56,520
Speaker 1: that the governance activities of Vanguard or black Rock do

444
00:23:56,720 --> 00:23:59,960
Speaker 1: differ in some ways of Elon Musk's governance activities. Yeah,

445
00:24:00,880 --> 00:24:03,760
Speaker 1: and that those could ostensibly lead to differences and how

446
00:24:03,800 --> 00:24:07,800
Speaker 1: aggressively management costs costs. That seems kind of obvious too.

447
00:24:08,440 --> 00:24:10,480
Speaker 1: That's basically the entire story. All I'm saying is that

448
00:24:11,240 --> 00:24:13,680
Speaker 1: um I, Vanguard doesn't do anything. I mean, they do something,

449
00:24:13,800 --> 00:24:17,520
Speaker 1: but if they did absolutely nothing to hold management accountable,

450
00:24:17,680 --> 00:24:20,920
Speaker 1: then probably this firm's costs would be higher. Well, the

451
00:24:21,000 --> 00:24:23,199
Speaker 1: firm's costs is the firm's costs are higher than it's

452
00:24:23,200 --> 00:24:25,680
Speaker 1: going to set higher prices. So that's my story. My

453
00:24:25,760 --> 00:24:30,160
Speaker 1: story is, look, index once are probably not the best. UM.

454
00:24:30,440 --> 00:24:34,280
Speaker 1: You know, activists investors to hold management accountable, and you're

455
00:24:34,280 --> 00:24:36,639
Speaker 1: going to see that in the firm's productivity and therefore

456
00:24:36,720 --> 00:24:39,320
Speaker 1: in product prices. Okay, so it's not a giant conspiracy.

457
00:24:39,520 --> 00:24:42,480
Speaker 1: Go ahead, Yeah, I agree. I agree because UM one

458
00:24:42,560 --> 00:24:45,640
Speaker 1: quick anecdote here and I just love this story. Eric Posner,

459
00:24:45,680 --> 00:24:48,480
Speaker 1: who did he? Did you work with Eric Posner of Chicago?

460
00:24:49,800 --> 00:24:51,359
Speaker 1: I didn't work with him my home very well, but

461
00:24:51,480 --> 00:24:53,600
Speaker 1: we we haven't worked together yet. So he also wrote

462
00:24:53,600 --> 00:24:56,159
Speaker 1: about this, and I um went and when I was

463
00:24:56,240 --> 00:24:59,400
Speaker 1: researching the Bogel book, I found a video of Jack

464
00:24:59,480 --> 00:25:03,600
Speaker 1: Bogel in a little Princeton office with Bert Malchiel, Cliff Fastness,

465
00:25:03,680 --> 00:25:06,360
Speaker 1: Andrew Low of m I t there was like seven

466
00:25:06,440 --> 00:25:10,040
Speaker 1: or eight heavyweight thinkers in there, and Eric and Jack

467
00:25:10,160 --> 00:25:12,520
Speaker 1: just wanted to talk this out because it was getting

468
00:25:12,560 --> 00:25:14,840
Speaker 1: some media attention. This is like six months before he

469
00:25:14,840 --> 00:25:17,920
Speaker 1: passed away. That's how hardcore Bogel was and how passionate

470
00:25:18,000 --> 00:25:20,200
Speaker 1: he was towards this stuff. But I I watched the

471
00:25:20,240 --> 00:25:22,840
Speaker 1: whole video. They didn't really come to any conclusion. I

472
00:25:23,040 --> 00:25:25,359
Speaker 1: felt that the passive side one, but I might have

473
00:25:25,400 --> 00:25:27,720
Speaker 1: been rooting for that side. I don't know. Um, but

474
00:25:27,840 --> 00:25:30,040
Speaker 1: people should go just google it. It's um on the

475
00:25:30,080 --> 00:25:33,399
Speaker 1: Princeton website and you can watch it and make up

476
00:25:33,440 --> 00:25:35,240
Speaker 1: your own mind. But one of the things that was

477
00:25:35,280 --> 00:25:37,000
Speaker 1: in there was this Gus Souter, who was c i

478
00:25:37,080 --> 00:25:39,400
Speaker 1: O at the time when Vanguard was getting bigger and bigger.

479
00:25:40,119 --> 00:25:42,960
Speaker 1: He was like, we've we do not collude with black Rock.

480
00:25:43,040 --> 00:25:45,040
Speaker 1: We we're we're honestly trying to vote in a way

481
00:25:45,080 --> 00:25:46,840
Speaker 1: that's you know, for the benefit of the of the

482
00:25:46,920 --> 00:25:49,119
Speaker 1: company's long term health. And if you look, they have

483
00:25:49,200 --> 00:25:52,600
Speaker 1: corporate governance teams that pay attention to this stuff and

484
00:25:52,640 --> 00:25:55,040
Speaker 1: they do vote differently. Even black Rock differs from Vanguard

485
00:25:55,080 --> 00:25:57,879
Speaker 1: in certain votes. Um, we've studied it. I would I

486
00:25:57,920 --> 00:26:01,159
Speaker 1: would agree it's not aggressive, it's not active. So given that,

487
00:26:01,359 --> 00:26:02,960
Speaker 1: you know, knowing their voting to try to keep the

488
00:26:02,960 --> 00:26:05,400
Speaker 1: company honest and do a good job, you still think

489
00:26:05,480 --> 00:26:09,840
Speaker 1: this common ownership is a problem. Yeah, So, um again,

490
00:26:09,920 --> 00:26:12,719
Speaker 1: I agree with everything you said. Um. So, the most

491
00:26:12,760 --> 00:26:15,800
Speaker 1: important part is that none of this this theory that

492
00:26:16,040 --> 00:26:19,560
Speaker 1: is being discussed here really has anything to do with collusion,

493
00:26:20,240 --> 00:26:24,120
Speaker 1: actually explicitly not not collusion between firms, not collusion between

494
00:26:24,160 --> 00:26:28,159
Speaker 1: different types of shareholders. Whenever an industry representative talks about

495
00:26:28,480 --> 00:26:31,480
Speaker 1: how they don't collude, that's a complete strong man. None

496
00:26:31,520 --> 00:26:35,080
Speaker 1: of these series is about collusion. Again, the theory is

497
00:26:35,160 --> 00:26:38,320
Speaker 1: just about they are probably not as active owners as

498
00:26:38,359 --> 00:26:41,119
Speaker 1: other investors. So let me tell you a story, and

499
00:26:41,160 --> 00:26:43,159
Speaker 1: I'm want to get your take on this. Two or

500
00:26:43,240 --> 00:26:46,399
Speaker 1: three years ago, this small company called Tanger Outlets. I

501
00:26:46,520 --> 00:26:48,399
Speaker 1: might even be pronouncing it wrong, that's how small this

502
00:26:48,480 --> 00:26:51,200
Speaker 1: company was. There was a time when it had fifty

503
00:26:51,359 --> 00:26:54,720
Speaker 1: five or sixty percent of its shares owned by index

504
00:26:54,800 --> 00:26:58,000
Speaker 1: funds and ETFs. It's a long story, but this dividend

505
00:26:58,040 --> 00:27:02,480
Speaker 1: fund owned because that stock was going down and it

506
00:27:02,600 --> 00:27:05,480
Speaker 1: kicked out a big dividend. But Active was selling off

507
00:27:05,520 --> 00:27:08,920
Speaker 1: the stock, but Passive liked the yield, so Passive ended

508
00:27:08,960 --> 00:27:11,320
Speaker 1: up buying it from Active over like two years, and

509
00:27:11,359 --> 00:27:14,359
Speaker 1: all of a sudden, Passive I called the I R

510
00:27:14,440 --> 00:27:17,440
Speaker 1: woman and I and I asked her, you know, what,

511
00:27:18,160 --> 00:27:20,960
Speaker 1: what do you think of this? Like? Is this um? Uh?

512
00:27:21,640 --> 00:27:23,400
Speaker 1: She goes, I don't think of it at all. I said,

513
00:27:23,560 --> 00:27:25,520
Speaker 1: she goes. I will say that the passive owners are

514
00:27:25,520 --> 00:27:29,560
Speaker 1: a little less engaged. But we're trying to like make payrolls,

515
00:27:29,600 --> 00:27:31,600
Speaker 1: like we're trying to make money here, We're not really

516
00:27:31,640 --> 00:27:33,840
Speaker 1: we don't really care who owns us. We are we

517
00:27:33,960 --> 00:27:36,520
Speaker 1: have bigger fish to fry. So isn't it true that

518
00:27:36,640 --> 00:27:40,639
Speaker 1: just business and capitalism also just kind of solves this

519
00:27:40,800 --> 00:27:43,399
Speaker 1: and we don't have to worry about that much? Have

520
00:27:43,560 --> 00:27:46,119
Speaker 1: you talked to a Twitter employee lately? I mean, it

521
00:27:46,160 --> 00:27:49,040
Speaker 1: doesn't It strikes me that the change in ownership that

522
00:27:49,200 --> 00:27:51,440
Speaker 1: came with Elon Musk buying a large stick in the

523
00:27:51,520 --> 00:27:54,119
Speaker 1: firm and putting a huge amount of pressure on that

524
00:27:54,200 --> 00:27:58,840
Speaker 1: thing becoming profitable rather changed the cost cutting incentives um

525
00:27:59,080 --> 00:28:01,880
Speaker 1: off the CEO or of the firm. No, so, I'm

526
00:28:01,920 --> 00:28:03,840
Speaker 1: not saying Mega doesn't do anything. I'm saying they do

527
00:28:03,960 --> 00:28:08,959
Speaker 1: less right, And perhaps a better comparison is um berta

528
00:28:09,000 --> 00:28:11,280
Speaker 1: had Away. Right, So let's think of Warren Buffett. Warren

529
00:28:11,320 --> 00:28:14,879
Speaker 1: Buffett occasionally by his firms and gets engaged in governance. No,

530
00:28:15,080 --> 00:28:18,359
Speaker 1: so we all immediately think of Coca Cola presumably or

531
00:28:18,400 --> 00:28:22,159
Speaker 1: American Express. Right, So, Warren Buffet ocation would put himself

532
00:28:22,200 --> 00:28:25,480
Speaker 1: on the board. Now, let's take the other situation. Warren

533
00:28:25,520 --> 00:28:28,520
Speaker 1: Buffett by is huge steaks in the three or four

534
00:28:28,600 --> 00:28:31,119
Speaker 1: largest airlines in the US. Did he put himself on

535
00:28:31,160 --> 00:28:34,280
Speaker 1: the board as well? And the answer is no, right,

536
00:28:34,520 --> 00:28:36,360
Speaker 1: so he did not put himself on the board. There

537
00:28:36,800 --> 00:28:41,160
Speaker 1: he gets less actively engaged UM with companies where he

538
00:28:41,240 --> 00:28:44,400
Speaker 1: also buys the competition. And that's exactly what economic theory

539
00:28:44,480 --> 00:28:47,760
Speaker 1: would predict. You simply don't have an incentive to engage

540
00:28:47,800 --> 00:28:50,440
Speaker 1: strongly with one company with part of the one company's

541
00:28:50,440 --> 00:28:53,160
Speaker 1: success comes at the expense of another company that you

542
00:28:53,240 --> 00:28:55,640
Speaker 1: own as well. So my point as well, there's a

543
00:28:55,760 --> 00:28:58,960
Speaker 1: reason Vanguard and Black Rock have governance teams, but the

544
00:28:59,040 --> 00:29:03,040
Speaker 1: governance teams are nowhere close to um, you know, the

545
00:29:03,120 --> 00:29:06,360
Speaker 1: intensity of the Bill Ackman or you know, any type

546
00:29:06,400 --> 00:29:11,040
Speaker 1: of activist investor who's the alternative largest shareholder of the firm. So, yeah,

547
00:29:11,080 --> 00:29:13,080
Speaker 1: that is something, But is it good enough? Well, I

548
00:29:13,120 --> 00:29:16,800
Speaker 1: mean it's less right. And if management is held to

549
00:29:16,920 --> 00:29:20,200
Speaker 1: account less actively UM, then the costs are going to

550
00:29:20,280 --> 00:29:22,240
Speaker 1: be higher and the price is going to be higher.

551
00:29:22,600 --> 00:29:25,200
Speaker 1: So that's it. It's a very boring story in some ways.

552
00:29:25,240 --> 00:29:27,240
Speaker 1: You know, it has nothing to do with collusion, has

553
00:29:27,280 --> 00:29:29,720
Speaker 1: nothing to do with evil motives. It just has something

554
00:29:29,760 --> 00:29:32,920
Speaker 1: to do with incentives to engage in corporate governance and

555
00:29:33,400 --> 00:29:36,640
Speaker 1: you know costs being a little higher when the shareholders

556
00:29:36,680 --> 00:29:41,920
Speaker 1: basically let management room free. So with that said, you know,

557
00:29:42,120 --> 00:29:46,360
Speaker 1: Vanguard and black Rock and Schwab have all announced initial

558
00:29:46,440 --> 00:29:50,720
Speaker 1: pilot programs to decentralize the share voting so that it's

559
00:29:50,760 --> 00:29:53,680
Speaker 1: not so centralized it's just them now. I would say

560
00:29:53,720 --> 00:29:56,400
Speaker 1: that the individual voters, like the thirty million Vanguard and voters,

561
00:29:56,720 --> 00:29:59,120
Speaker 1: many may just opt to have Vanguard do it, but

562
00:29:59,760 --> 00:30:01,360
Speaker 1: many may opt to have a third party to it.

563
00:30:01,920 --> 00:30:04,640
Speaker 1: Schwab is looking at polling just to get there where

564
00:30:04,640 --> 00:30:06,320
Speaker 1: their head is at and then vote that way, because

565
00:30:06,480 --> 00:30:08,360
Speaker 1: I don't think an individual investor. What's the deal with

566
00:30:08,440 --> 00:30:11,120
Speaker 1: all of these proxy votes? It's really boring and time

567
00:30:11,200 --> 00:30:14,680
Speaker 1: consuming and most of them are not really consequential. Um,

568
00:30:15,040 --> 00:30:18,480
Speaker 1: do you think that decentralized trend could help this at all?

569
00:30:19,640 --> 00:30:22,360
Speaker 1: I think you just said it right. Um. So, first

570
00:30:22,400 --> 00:30:24,440
Speaker 1: of all, it's a it's an interesting question, it's a

571
00:30:24,520 --> 00:30:28,560
Speaker 1: very interesting question. But if the problem is that Vanguard's

572
00:30:28,600 --> 00:30:32,080
Speaker 1: governance team with the cloud of all these assets and

573
00:30:32,240 --> 00:30:36,080
Speaker 1: the associated votes if they don't use that very effectively

574
00:30:36,160 --> 00:30:38,640
Speaker 1: because they don't have incentives, and now you give it

575
00:30:38,680 --> 00:30:42,200
Speaker 1: to shareholders that are equally diversified, but having even lower

576
00:30:42,240 --> 00:30:45,320
Speaker 1: incentive and less expertise to be engaged. It's not clear

577
00:30:45,360 --> 00:30:47,640
Speaker 1: that this is going to help the problem. Right, So

578
00:30:48,840 --> 00:30:51,480
Speaker 1: I'm doubtful that this would be a solution to the problem.

579
00:30:52,480 --> 00:30:54,320
Speaker 1: But and let's go to the problem one more time.

580
00:30:55,040 --> 00:30:58,000
Speaker 1: I lam a sniff test guy, you know, and I

581
00:30:58,080 --> 00:31:02,760
Speaker 1: think that matters. I haven't really seen anything that I

582
00:31:02,800 --> 00:31:05,640
Speaker 1: can touch or feel that has been a byproduct of

583
00:31:05,720 --> 00:31:09,280
Speaker 1: this concern. Like, it seems like competitions alive, and I

584
00:31:09,320 --> 00:31:12,680
Speaker 1: haven't seen one industry where prices just got crazy. I mean,

585
00:31:12,720 --> 00:31:15,480
Speaker 1: I know inflation went up recently, but that was largely

586
00:31:15,520 --> 00:31:17,640
Speaker 1: a function of you know, the lockdown and the FED

587
00:31:17,720 --> 00:31:21,240
Speaker 1: and whatnot. So have you seen anything specific that is

588
00:31:21,280 --> 00:31:23,760
Speaker 1: a direct result of this or is it just a

589
00:31:23,880 --> 00:31:25,720
Speaker 1: little too hard to measure or a little too early

590
00:31:25,800 --> 00:31:29,040
Speaker 1: to measure? Yeah, So look, that's a that's the crux

591
00:31:29,520 --> 00:31:32,760
Speaker 1: that theory that I'm pronouncing here that's been around for decades.

592
00:31:32,840 --> 00:31:35,360
Speaker 1: It was actually a Princeton guy as well, Prince Princeton

593
00:31:35,400 --> 00:31:37,520
Speaker 1: graduate who came up with that in his first job

594
00:31:37,600 --> 00:31:40,840
Speaker 1: at a M I. T Um. And if you try

595
00:31:40,920 --> 00:31:43,800
Speaker 1: to test that using the time series of our overall

596
00:31:43,880 --> 00:31:46,760
Speaker 1: price levels higher or lower, you can't get very far right,

597
00:31:46,800 --> 00:31:50,040
Speaker 1: because there's all these alternative explanations. But the claim to

598
00:31:50,120 --> 00:31:55,360
Speaker 1: fame of that first paper is that we study differences

599
00:31:55,560 --> 00:31:59,560
Speaker 1: in particular roots. So say you know, some airlines become

600
00:31:59,640 --> 00:32:02,000
Speaker 1: more owned by say the black Rocks and bang Ards

601
00:32:02,080 --> 00:32:06,520
Speaker 1: and perhaps the Berkshire Hathaways over time, so they become

602
00:32:06,560 --> 00:32:09,680
Speaker 1: more commonly owned. And in the theory, that would make

603
00:32:09,800 --> 00:32:12,800
Speaker 1: those and the roots where they compete set higher prices

604
00:32:13,200 --> 00:32:16,120
Speaker 1: whereas other airlines don't. Right. So there's Richard Branson owning

605
00:32:17,040 --> 00:32:20,959
Speaker 1: Virgin America and being behind the CEO and cost cutting

606
00:32:21,120 --> 00:32:23,120
Speaker 1: and going to the media all the time promoting the

607
00:32:23,200 --> 00:32:27,400
Speaker 1: products and so forth, right, And the test um the

608
00:32:27,480 --> 00:32:29,960
Speaker 1: proof of the pudding of the theory here was in

609
00:32:30,120 --> 00:32:33,880
Speaker 1: seeing how say, the Virgin America has compete with the

610
00:32:34,000 --> 00:32:36,440
Speaker 1: Deltas in the United's of this world. And what you

611
00:32:36,480 --> 00:32:39,920
Speaker 1: see very clearly there is that the prices go up

612
00:32:40,360 --> 00:32:44,480
Speaker 1: when the airlines become more commonly owned, compared to price

613
00:32:44,600 --> 00:32:48,040
Speaker 1: changes in routs where there's less common ownership, and the

614
00:32:48,080 --> 00:32:50,120
Speaker 1: common ownership does not go up. Yeah it doesn't. That

615
00:32:50,240 --> 00:32:52,160
Speaker 1: is where the proof of the pudding is. Yeah, it doesn't.

616
00:32:52,200 --> 00:32:55,200
Speaker 1: The common ownership self police itself because if you are

617
00:32:55,240 --> 00:32:57,040
Speaker 1: a common owner of all the airlines, you're also a

618
00:32:57,080 --> 00:32:59,320
Speaker 1: common owner of, like I don't know, all of the

619
00:32:59,400 --> 00:33:02,680
Speaker 1: tech company season all of the industrial companies. And if

620
00:33:02,720 --> 00:33:06,880
Speaker 1: airline prices go up, then it's gonna hurt business travel,

621
00:33:07,000 --> 00:33:08,920
Speaker 1: which might just end up hurting a lot of the

622
00:33:08,960 --> 00:33:13,880
Speaker 1: other sectors that you own. So doesn't higher prices ruin

623
00:33:14,280 --> 00:33:18,640
Speaker 1: other things? Therefore, you would, as as an index fun owner,

624
00:33:19,200 --> 00:33:21,880
Speaker 1: not want that because you're you're looking after all the sectors,

625
00:33:21,960 --> 00:33:24,800
Speaker 1: not just this one. Yeah. I think that's an argument

626
00:33:24,880 --> 00:33:29,080
Speaker 1: that makes sense in in some cases more so than

627
00:33:29,120 --> 00:33:32,160
Speaker 1: in others. Right, So airlines, most of the tickets get

628
00:33:32,200 --> 00:33:34,080
Speaker 1: sold to the end, to the end consumers and not

629
00:33:34,200 --> 00:33:36,840
Speaker 1: to other businesses. But you could say, well, what about

630
00:33:36,880 --> 00:33:39,680
Speaker 1: oil companies. A lot of the airlines cost is oil,

631
00:33:40,040 --> 00:33:41,720
Speaker 1: So what if you have common ownership between the oil

632
00:33:41,760 --> 00:33:44,800
Speaker 1: companies and the air line companies. And indeed there's evidence

633
00:33:44,880 --> 00:33:47,880
Speaker 1: that this leads to lower prices. So more common ownership

634
00:33:48,240 --> 00:33:52,720
Speaker 1: between vertically related firms so suppliers and customers actually tends

635
00:33:52,720 --> 00:33:55,480
Speaker 1: to lower prices, which is one more reason why it's

636
00:33:55,520 --> 00:33:59,560
Speaker 1: really not about indexing. Right, So the problem for competition

637
00:33:59,680 --> 00:34:02,160
Speaker 1: is not come from indexing, or at least nobody has

638
00:34:02,200 --> 00:34:05,360
Speaker 1: shown that it does. The problem with competition comes from

639
00:34:05,960 --> 00:34:10,120
Speaker 1: the same investors holding horizontal competitors. And what the overall

640
00:34:10,120 --> 00:34:14,200
Speaker 1: effect on indexing or passive is on competition. Nobody has

641
00:34:14,280 --> 00:34:17,560
Speaker 1: even started to properly address that. And that's actually where

642
00:34:17,680 --> 00:34:20,239
Speaker 1: you know, that first paper we talked about comes in again.

643
00:34:20,560 --> 00:34:22,200
Speaker 1: You know, when you look at the airlines alone and

644
00:34:22,239 --> 00:34:25,840
Speaker 1: then just say look and the economy consists of a

645
00:34:25,880 --> 00:34:29,319
Speaker 1: whole bunch of industries, they become more commonly owned. Let's

646
00:34:29,320 --> 00:34:32,360
Speaker 1: fix the problem that's prohibit indexing. Well, let does not

647
00:34:32,520 --> 00:34:35,520
Speaker 1: take into account that there are vertically related firms. It

648
00:34:35,600 --> 00:34:39,040
Speaker 1: does not take into account that, hey, asset prices might

649
00:34:39,120 --> 00:34:40,960
Speaker 1: go up. And here's the thing that was missing from

650
00:34:40,960 --> 00:34:43,480
Speaker 1: the first paper. When asset prices are up and expected

651
00:34:43,520 --> 00:34:47,480
Speaker 1: returns are low, well, uh, that actually reduces the cost

652
00:34:47,560 --> 00:34:50,719
Speaker 1: of capital firms. And wouldn't that be something that potentially

653
00:34:50,800 --> 00:34:53,800
Speaker 1: makes some expand output, right, And those are things that

654
00:34:53,880 --> 00:34:56,920
Speaker 1: are simply not present in the economic theories um of

655
00:34:57,080 --> 00:34:59,359
Speaker 1: the day, and those are just directing limitations one has

656
00:34:59,440 --> 00:35:03,440
Speaker 1: to acknowledge when debating these policy proposals. So in the

657
00:35:03,480 --> 00:35:06,920
Speaker 1: common ownership last question on this, is there a public policy?

658
00:35:07,040 --> 00:35:08,400
Speaker 1: I know the first one you said, there's really no

659
00:35:08,760 --> 00:35:11,320
Speaker 1: policy recommendation. Would you have a policy recommendation on the

660
00:35:11,320 --> 00:35:14,520
Speaker 1: common ownership issue? Is like maybe, um, you can't own

661
00:35:14,560 --> 00:35:18,359
Speaker 1: more than three or of the industry. I mean, would

662
00:35:18,400 --> 00:35:22,160
Speaker 1: you before instituting something like that, which would also ultimately

663
00:35:22,239 --> 00:35:26,920
Speaker 1: make index funds illegal. So that's a good one, right, So, UM,

664
00:35:27,239 --> 00:35:31,280
Speaker 1: there are policy proposals. I'm saying I have not myself

665
00:35:31,880 --> 00:35:35,360
Speaker 1: endorsed any or or made any but in the legal scholarship,

666
00:35:36,040 --> 00:35:38,960
Speaker 1: the journals are full in the last five years of

667
00:35:39,040 --> 00:35:42,800
Speaker 1: all the policy proposals that go from anywhere from you know,

668
00:35:43,080 --> 00:35:46,360
Speaker 1: let's just take all the voting rights away from index funds,

669
00:35:46,600 --> 00:35:50,960
Speaker 1: or let's say we provide a safe haven for any

670
00:35:51,040 --> 00:35:54,359
Speaker 1: investor who holds less than one percent of all the firms, um,

671
00:35:54,600 --> 00:35:57,680
Speaker 1: and otherwise you know, the antitrust laws apply. So other

672
00:35:57,680 --> 00:36:00,800
Speaker 1: people have made these proposals, and I have, and basically

673
00:36:00,880 --> 00:36:04,080
Speaker 1: for the reasons that I just that I just mentioned, Um,

674
00:36:04,360 --> 00:36:07,160
Speaker 1: there's a whole bunch of open questions that I think

675
00:36:07,200 --> 00:36:09,319
Speaker 1: have to be addressed. But another reason is there's much

676
00:36:09,360 --> 00:36:12,279
Speaker 1: more low hanging fruit. Why why do we focus on

677
00:36:12,840 --> 00:36:15,200
Speaker 1: the black rocks and the vanguards of this world? Why

678
00:36:15,280 --> 00:36:20,080
Speaker 1: nobody takes any issue with Berkshire Hathaway buying in the

679
00:36:20,160 --> 00:36:24,239
Speaker 1: competing airlines. Nobody raises an eyebrow or and this is

680
00:36:24,280 --> 00:36:29,120
Speaker 1: a that's a literal example, Bill Gates family office buying

681
00:36:29,239 --> 00:36:32,920
Speaker 1: thirty percent stakes in the publicly traded waste management companies,

682
00:36:33,480 --> 00:36:36,360
Speaker 1: Like why why do we debate whether Vanguard has an

683
00:36:36,400 --> 00:36:38,480
Speaker 1: effect on passive? Why we just tolerate that and not

684
00:36:38,560 --> 00:36:41,960
Speaker 1: even scrutinize it. So I think the there's much more

685
00:36:42,040 --> 00:36:44,400
Speaker 1: low hanging fruit. And and there's no none of these

686
00:36:44,440 --> 00:36:47,040
Speaker 1: concerns that we just mentioned about vertically integrated firms and

687
00:36:47,120 --> 00:36:49,600
Speaker 1: equilibrium effects and all this good stuff. We don't have

688
00:36:49,719 --> 00:36:53,160
Speaker 1: to debate that when it's about a particular relatively small

689
00:36:53,200 --> 00:36:57,840
Speaker 1: investor basically deliberately buying shares and competitors um, then I

690
00:36:57,840 --> 00:37:01,680
Speaker 1: don't really understand why why we're putting so much attention

691
00:37:02,360 --> 00:37:04,919
Speaker 1: on the big index funds. So I think there's lower

692
00:37:04,960 --> 00:37:09,319
Speaker 1: hanging fruit for the policy makers than debate these structural proposals. Uh, yeah,

693
00:37:09,360 --> 00:37:11,239
Speaker 1: I know those are good points. Um. And I brought

694
00:37:11,400 --> 00:37:14,200
Speaker 1: these worries up with Bogel and um one of my

695
00:37:14,320 --> 00:37:16,800
Speaker 1: interviews with him just before he passed away, and he

696
00:37:16,960 --> 00:37:20,759
Speaker 1: addressed Eric Posner specifically that you know, you get these

697
00:37:20,800 --> 00:37:22,080
Speaker 1: worries all of a sudden, they get into the New

698
00:37:22,120 --> 00:37:24,520
Speaker 1: York Times, and they get written about the wrong way

699
00:37:24,560 --> 00:37:26,760
Speaker 1: straw man, as you would say, and all of a sudden,

700
00:37:26,880 --> 00:37:30,480
Speaker 1: you know, he specifically mentioned Elizabeth Warren sees it as

701
00:37:30,520 --> 00:37:33,400
Speaker 1: something she can run on because it's like her versus

702
00:37:33,440 --> 00:37:36,600
Speaker 1: the big guys, and all of a sudden, bam, you

703
00:37:36,800 --> 00:37:39,400
Speaker 1: just ruined this golden goose for small investors, which is

704
00:37:39,480 --> 00:37:42,080
Speaker 1: a cheap index fund. And that's the worry of the

705
00:37:42,160 --> 00:37:46,800
Speaker 1: some worry articles. So so look, I'm laughing because this

706
00:37:46,920 --> 00:37:49,880
Speaker 1: is where the circle closes. And that makes me a

707
00:37:49,920 --> 00:37:53,719
Speaker 1: little happy. Right. The policy trade of as it is illustrated,

708
00:37:53,920 --> 00:37:57,120
Speaker 1: is being thought of as diversification is good for the

709
00:37:57,200 --> 00:38:00,799
Speaker 1: small investors. But if we inter emed, then we would

710
00:38:00,840 --> 00:38:03,240
Speaker 1: take that away from them. And that's what's so important

711
00:38:03,239 --> 00:38:06,040
Speaker 1: about the first paper, the first paper which says, wait,

712
00:38:06,239 --> 00:38:09,439
Speaker 1: it's actually much less obvious than we thought whether cheap

713
00:38:09,480 --> 00:38:13,400
Speaker 1: indexing is actually good for small investors. All right, So

714
00:38:13,680 --> 00:38:15,960
Speaker 1: my point is I think that first paper doesn't have

715
00:38:16,040 --> 00:38:19,360
Speaker 1: policy implications on its own, but it does make you

716
00:38:19,440 --> 00:38:22,200
Speaker 1: think differently about the policy trade offs that are to

717
00:38:22,280 --> 00:38:24,440
Speaker 1: be considered when it goes when we're talking about these

718
00:38:24,480 --> 00:38:27,200
Speaker 1: other side effects, like the effects on competition. There's a

719
00:38:27,239 --> 00:38:37,239
Speaker 1: lot of layers to this. You own passive, right, This

720
00:38:37,400 --> 00:38:39,280
Speaker 1: is where I really like, I just want to close

721
00:38:39,360 --> 00:38:43,000
Speaker 1: with this. What what what would you need to see

722
00:38:43,560 --> 00:38:46,960
Speaker 1: to make you take one for the team and move

723
00:38:47,080 --> 00:38:50,600
Speaker 1: over to a high cost or a higher cost active

724
00:38:50,640 --> 00:38:53,560
Speaker 1: fund or something different with your money, because I think

725
00:38:53,640 --> 00:38:55,799
Speaker 1: that's sort of what other people would need to see

726
00:38:56,080 --> 00:38:58,680
Speaker 1: because if you, who looks right at this closest, is

727
00:38:58,719 --> 00:39:01,319
Speaker 1: still in index funds, it's gonna take a whole lot

728
00:39:01,400 --> 00:39:07,319
Speaker 1: more to convince anyone else to leave. No. So, um, yeah,

729
00:39:07,360 --> 00:39:11,040
Speaker 1: you're not gonna get me to divest from passive until

730
00:39:11,080 --> 00:39:14,319
Speaker 1: you make it expensive. Now, So that's what regulation is for. Look,

731
00:39:14,360 --> 00:39:16,719
Speaker 1: I'll tell you a story of little Martin being in

732
00:39:16,760 --> 00:39:19,040
Speaker 1: the grocery store when I was I don't know, seven

733
00:39:19,120 --> 00:39:22,640
Speaker 1: years old, and my mom showed me how the flowers

734
00:39:22,800 --> 00:39:25,640
Speaker 1: were flown in from I don't know, South America or

735
00:39:25,680 --> 00:39:28,520
Speaker 1: Africa or I don't know where, and how that bad

736
00:39:28,640 --> 00:39:30,680
Speaker 1: was that for the climate, and therefore we should just

737
00:39:30,800 --> 00:39:34,680
Speaker 1: shun that and not buy these products and so forth. Look,

738
00:39:34,800 --> 00:39:38,160
Speaker 1: what I see is that despite these effects, these efforts

739
00:39:38,200 --> 00:39:41,080
Speaker 1: by my mom um to get people to not buy

740
00:39:41,200 --> 00:39:44,680
Speaker 1: what is attractive to them, somehow they took over and

741
00:39:44,840 --> 00:39:47,120
Speaker 1: flowers are still being grown and flown around the globe.

742
00:39:47,920 --> 00:39:50,359
Speaker 1: Perhaps that's bad for the for the climate. But it's

743
00:39:50,480 --> 00:39:54,000
Speaker 1: not the job of individual consumers to fix that. That's

744
00:39:54,040 --> 00:39:56,759
Speaker 1: the job of policy makers. So you know, that's a

745
00:39:56,800 --> 00:40:00,600
Speaker 1: broader point. But the entire structure of the problem that

746
00:40:00,640 --> 00:40:04,320
Speaker 1: I'm talking about is that for individual investors, it is

747
00:40:04,400 --> 00:40:08,279
Speaker 1: perfectly rational to keep buying passive funds. And that's what

748
00:40:08,400 --> 00:40:10,400
Speaker 1: I do, because you know, I try to be a

749
00:40:10,520 --> 00:40:13,799
Speaker 1: rational person most of the time. But that doesn't mean

750
00:40:13,840 --> 00:40:16,960
Speaker 1: that it's good for you know, societies. And that's what

751
00:40:17,040 --> 00:40:19,719
Speaker 1: the role of the role of policymakers is, which is

752
00:40:19,760 --> 00:40:21,759
Speaker 1: why you know, I see it so critically or with

753
00:40:21,840 --> 00:40:24,839
Speaker 1: so much concern when politicians lean back and go like, look,

754
00:40:24,960 --> 00:40:27,920
Speaker 1: let's just hand over world world government to you know,

755
00:40:28,080 --> 00:40:30,759
Speaker 1: the big asset managers. Surely they care about the world

756
00:40:30,840 --> 00:40:33,680
Speaker 1: just as much as you know people do. And so

757
00:40:33,840 --> 00:40:36,120
Speaker 1: I think that's just faulty logic. That is literally the

758
00:40:36,280 --> 00:40:40,000
Speaker 1: role that politicians are supposed to play in an economic system,

759
00:40:40,040 --> 00:40:41,840
Speaker 1: and not the investors. So I don't think the investors

760
00:40:41,840 --> 00:40:46,040
Speaker 1: are to blame, nor should they change anything. The ball

761
00:40:46,160 --> 00:40:47,880
Speaker 1: is in the court of the politicians here. Okay, So

762
00:40:48,040 --> 00:40:51,680
Speaker 1: let's say the politicians said they reversed the Vanguard effect

763
00:40:51,719 --> 00:40:54,359
Speaker 1: from forty five years and said index funds can exist,

764
00:40:54,440 --> 00:40:56,680
Speaker 1: but they can be no cheaper than ninety basis points.

765
00:40:57,480 --> 00:41:00,279
Speaker 1: How would you as an individual investor that hold index funds,

766
00:41:00,320 --> 00:41:04,520
Speaker 1: feels like, what would your reaction to that be. I mean, look,

767
00:41:04,640 --> 00:41:07,279
Speaker 1: I'm kind of rich, so I would probably still hold

768
00:41:07,320 --> 00:41:10,000
Speaker 1: funds and make way higher returns, So I'd probably benefit

769
00:41:10,040 --> 00:41:15,680
Speaker 1: from that policy, and you're probably among that camp as well.

770
00:41:17,120 --> 00:41:19,840
Speaker 1: But well, I would feel bummed because I've looked at

771
00:41:19,880 --> 00:41:23,600
Speaker 1: the numbers. If you pay even one percent more over

772
00:41:23,680 --> 00:41:27,000
Speaker 1: fifty years of compounding, we're talking hundreds of thousands of

773
00:41:27,080 --> 00:41:30,080
Speaker 1: dollars that go to the industry and not you. It

774
00:41:30,200 --> 00:41:33,600
Speaker 1: adds up over time, and so even ninety basis points

775
00:41:33,719 --> 00:41:36,959
Speaker 1: or a hundred and fifty even ten over enough time

776
00:41:37,120 --> 00:41:38,920
Speaker 1: can be a lot of dollars and cents. And I

777
00:41:38,960 --> 00:41:41,640
Speaker 1: think that's where if you're an individual investor who's looked

778
00:41:41,680 --> 00:41:44,360
Speaker 1: at those charts, you'd be like, wow, what a bummer.

779
00:41:44,920 --> 00:41:49,919
Speaker 1: Absolutely so look, um, we were on the same page

780
00:41:49,960 --> 00:41:53,800
Speaker 1: on that. I just started a bunch of college savings

781
00:41:53,840 --> 00:41:56,440
Speaker 1: accounts for my kids, and in Europe you do not

782
00:41:56,560 --> 00:42:00,440
Speaker 1: get excess necessarily to these fantastically cheap index products. I

783
00:42:00,520 --> 00:42:03,600
Speaker 1: got one for what like ad basis points from some

784
00:42:03,760 --> 00:42:07,759
Speaker 1: local German bank and it makes me amazingly upset. It's

785
00:42:07,800 --> 00:42:10,840
Speaker 1: basically a rip off, and I'm very upset at that.

786
00:42:11,280 --> 00:42:13,920
Speaker 1: I get even more upset when I think about how

787
00:42:13,960 --> 00:42:17,520
Speaker 1: many millions of German savers there are UM that are

788
00:42:17,560 --> 00:42:20,640
Speaker 1: being ripped off without understanding that it could be so

789
00:42:20,760 --> 00:42:22,960
Speaker 1: much cheaper. We're totally on the same page about that.

790
00:42:23,520 --> 00:42:27,120
Speaker 1: But the reason for that is because um, here's a

791
00:42:27,200 --> 00:42:30,920
Speaker 1: few UM you know that's called it less sophisticated or

792
00:42:31,120 --> 00:42:35,400
Speaker 1: more heavily regulated UM investors that don't have access to

793
00:42:35,520 --> 00:42:38,600
Speaker 1: the cheap funds, but they still suffer from the lower

794
00:42:38,680 --> 00:42:41,520
Speaker 1: expected returns. So this is where the that's where the

795
00:42:41,560 --> 00:42:45,120
Speaker 1: trucks comes in. Of course, everybody agrees that cheaper funds

796
00:42:45,160 --> 00:42:47,919
Speaker 1: are better than more expensive funds at the same time,

797
00:42:48,080 --> 00:42:51,680
Speaker 1: but if nobody else was able to invest um at

798
00:42:52,000 --> 00:42:54,359
Speaker 1: such low costs, and therefore asset prices would be lower,

799
00:42:54,440 --> 00:42:56,360
Speaker 1: I think a lot of people would be happy. You know,

800
00:42:56,400 --> 00:42:58,520
Speaker 1: it's the same thing about houses, right, So I mean,

801
00:42:58,719 --> 00:43:01,080
Speaker 1: go in the street and talk to a twenty five

802
00:43:01,160 --> 00:43:04,000
Speaker 1: year old about whether they are happy or unhappy about

803
00:43:04,080 --> 00:43:07,279
Speaker 1: high house prices. Look, I mean, it's it's kind of

804
00:43:07,360 --> 00:43:09,560
Speaker 1: obvious that we're unhappy about that. That we spend a

805
00:43:09,640 --> 00:43:13,279
Speaker 1: greater fraction of our savings on assets that have a

806
00:43:13,360 --> 00:43:16,080
Speaker 1: particular dollar return. If we have to pay more for it,

807
00:43:16,280 --> 00:43:19,120
Speaker 1: we're clearly worse off. Right, So if you told them, hey,

808
00:43:19,320 --> 00:43:23,520
Speaker 1: let's um institute a reform that makes housing prices lower,

809
00:43:23,800 --> 00:43:26,120
Speaker 1: surely they would be happy about that, even though in

810
00:43:26,200 --> 00:43:28,120
Speaker 1: the face of it you can't immediately see it because

811
00:43:28,480 --> 00:43:30,920
Speaker 1: made you think about the fee that you're paying, but

812
00:43:31,040 --> 00:43:34,000
Speaker 1: you don't immediately understand that the equilibrium effect would be

813
00:43:34,400 --> 00:43:36,480
Speaker 1: that the prices are lower and you you get to

814
00:43:36,520 --> 00:43:39,480
Speaker 1: benefit from higher returns. All right, Well, Martin, we have

815
00:43:39,520 --> 00:43:42,000
Speaker 1: a fun way of closing the show. Um, we ask

816
00:43:42,160 --> 00:43:45,400
Speaker 1: everybody on here, what is your favorite e t F ticker.

817
00:43:46,840 --> 00:43:53,160
Speaker 1: It's VT the Vanguard Total World, which is a that's

818
00:43:53,239 --> 00:43:56,719
Speaker 1: total World stock index, fundily tax book indexing. That's what

819
00:43:56,840 --> 00:43:59,440
Speaker 1: I do. Nice that is that is as close to

820
00:43:59,560 --> 00:44:01,640
Speaker 1: pass of as you can get with an et F.

821
00:44:01,800 --> 00:44:05,400
Speaker 1: So that's it. Beautiful irony here that that that's your

822
00:44:05,440 --> 00:44:08,440
Speaker 1: favorite figure. It is good place to end anyway, Martin,

823
00:44:08,480 --> 00:44:11,319
Speaker 1: thank you for joining us on Trillions. Thank you very

824
00:44:11,400 --> 00:44:19,440
Speaker 1: much for the opportunity. Thanks for listening to Trillions until

825
00:44:19,560 --> 00:44:21,400
Speaker 1: next time. You can find us on the Bloomberg terminals,

826
00:44:21,520 --> 00:44:25,320
Speaker 1: Bloomberg dot com, Apple Podcast, Spotify, and wherever else you

827
00:44:25,400 --> 00:44:27,839
Speaker 1: like to listen. We'd love to hear from you. We're

828
00:44:27,880 --> 00:44:31,719
Speaker 1: on Twitter. I'm at Joel Weaper Show. He's at Eric Caltuness.

829
00:44:32,600 --> 00:44:36,319
Speaker 1: This episode of Trillions was produced by Magnus Hendrickson. Bye