[gregorymichael]

A bit click-baity, but the warning here from the father-of-index-funds is not that they've become a bad investment, but that their popularity is leading toward a handful of financial institutions holding controlling interests in most of the largest companies. Pretty interesting unitended consequence.

[nthot]

Anecdotally, I have a few friends who work in the railroad industry and they are currently seeing something close to this. The company is almost entirely owned by large institutional funds.

Union Pacific has a huge drive for constantly increasing efficiency. Their profits are up significantly year over year, but this fall they cut about 500 jobs from their headquarters in Omaha, around 6% of their Nebraska employees, and this isn't even the first time they've done it. To keep the big investors happy they are constantly searching for ways to cut costs.

On the other hand, this might also be a product of the industry. The railroad is necessarily growth constrained. It's unlikely that significantly more products will move to being transported by rail and there is very little room for new lines to be constructed.

[hangonhn]

I'm not entirely sure your conclusion is correct. Almost 40% of all US freight is moved via rail. The reason passenger trains suck in the US is because our railroads are built for and prioritized for freight. When Berkshire Hathaway purchased BNSF, they noted that trains connect companies between the two coasts of the US. It is often the case that a company that produces something is on one coast but the port where its products go out is literally a continent away. Even domestically bound products have to be shipped between coasts because of how population centers in the US are situated. So assuming the US population and industries continue to grow, I think freight rail will continue to be in demand.

[xenadu02]

Believe it or not, sometimes products are unloaded on one coast, transported by rail, then loaded on a ship on the other coast.

[chimeracoder]

> Believe it or not, sometimes products are unloaded on one coast, transported by rail, then loaded on a ship on the other coast.

That is surprising, since shipping by water is dramatically cheaper than any other form of surface shipping, even factoring the extra distance to sail down to the Panama Canal. What's the point of adding the land leg?

[SaintGhurka]

Maybe because the canal is too small? Prior to the opening of the new locks in 2016, the largest container ship that could fit through the Panama Canal was pretty small by modern standards. And even with the new locks opened some ships still have to go around the horn.

[ceejayoz]

Shipping via Panama doubles the distance, and it's probably half the speed as well. Some products will likely benefit from shaving off two or three weeks from China to the EU.

[pedrosorio]

Why would you ever go through America to ship something from China to the EU? (which are 6/7 time zones apart vs 17/18 going in the other direction)

[saghm]

Speed, maybe? I don't know offhand if it's faster or not, but if it is, I can imagine that spending more to get the products to their destination faster could be worth it in some scenarios.

[newnewpdro]

Isn't passage through the Panama Canal expensive?

[xxpor]

Expensive in absolute terms, yes.

Based on the calculator here:

https://www.wilhelmsen.com/tollcalculators/panama-toll-calcu...

It costs $1,196,397.54 for the largest possible ship to go though.

That's for 13,000 TEUs though (so 6500 standard containers) That's $184 per container. Now think about how much a container holds, and per item for sale it becomes pretty cheap.

[steamer25]

My Costa Rican brother-in-law was just telling me that a couple Central American countries are working on new canals because the Panama canal is fairly saturated.

[zacharycohn]

Because if you're in Kansas, there is no water route to the Pacific Ocean?

[Pfhreak]

The original quote was this:

> sometimes products are unloaded on one coast, transported by rail, then loaded on a ship on the other coast.

Not sure how Kansas is relevant...

[dmurray]

The big index funds aren't exactly known as activist investors. Even if it's "Wall Street" collectively, it's not Vanguard or State Street that is pushing Union Pacific to cut costs.

[jandrese]

It's a side effect of having real number feedback on how you're doing. Management can't just make up their own metrics anymore, there is a third party that tells you how well you are doing, and that third party wants to see constant growth or they'll start dropping your price and the financial press will pick up on that and start writing articles about how millennials are killing the rail industry.

It takes real gumption for the upper management to say "screw what the greedy bastards on Wall Street think, we're doing just fine." Especially when their yearly bonuses are tied to what those guys on Wall Street think.

[scott_s]

Your comment still assumes active investors who are looking for value stocks. Index funds don't discriminate, they just buy stocks in the entire market.

[whack]

Index funds don't discriminate against stocks, but they can discriminate against directors and executives who don't deliver their desired profits and returns. Ie, by voting them out. This is already starting to happen. See: https://www.barrons.com/articles/passive-investors-are-the-n...

[scott_s]

I mostly read about passive firms voting more on special issues like climate change or good governance. Where did they they talk about voting out directors who didn’t deliver profits? (Honest question, I mostly read the article, then came back to it and hit a paywall.)

[jandrese]

Right. In fact index funds should be better for management since they won't be rocking the boat so much.

[jonknee]

The pressure to increase profits exists regardless of ownership, if anything having large institutional funds own the majority lessens the pressure (vs an activist fund or something similar). If they're leaving money on the table someone is going to take it.

[xenadu02]

Not really; you can look at BNSF (bought by Buffet) vs Union Pacific. Buffet takes the long view, as a result BNSF has been spending billions on capital projects and hiring.

Wall St is known for encouraging short-term thinking.

[xkjkls]

I'd say it's a lie that Wall Street is known for short term thinking. Hell, it is even a unofficial motto of Goldman Sachs to "be long-term greedy".

Are there a large number of activist investors who want certain companies to trim fat? Yes. I wouldn't always say that trimming fat is always synonymous with short term thinking. For all the companies that are underinvesting in the future, there are 5 whose management has given them mission creep to invest in areas that incinerate capital. Especially in the current interest rate environment.

[whatok]

BNSF is spending money on capex because it's the smart thing to do in that industry right now. That's not a consequence of a Buffet investment. Buffet also invested in Heinz and they immediately fired thousands and are cutting costs left and right.

[atomical]

Buffett lays out some reasons why it's tougher for brands like Heinz.

https://www.cnbc.com/video/2018/05/07/buffett.html

[pmiller2]

You forgot: there's a hard ceiling to how high they can raise prices, because they have to compete with trucks. Together, that all implies that if they want higher earnings, cost cutting is the only way.

[hangonhn]

Uh... not sure if that's actually the case. Trains are cheaper and actually faster over a long distance. The optimal way to ship is actually intermodal: ship for between countries/continents, trains for long trips over land, and then trucks for the last leg. They don't really compete with each other as much as they work together, especially since they have a standardized protocol for inter-process communication known as containers. Of course electric automated trucks could change all that.

[pmiller2]

> Trains are cheaper [...] over a long distance.

Right there's your hard cap. Make trains too expensive relative to trucks, and, suddenly, everything goes most of the way by truck.

[ethbro]

> Of course electric automated trucks could change all that.

Unmanned trucks crossing long distances of rural America sounds like a recipe for hijacking loads.

[elsonrodriguez]

Hijacking trucks filled to the brim with sensors sounds like a recipe for jail time.

The logistics of stopping and looting a truck involves too many parties, and ensuring that each party is following enough security protocols to not be identified via face, vehicle, or gait will ensure that only a few small sophisticated heists will ever be successful.

[a3n]

Anecdata: a fellow driver told me the story of a truck stopped at a light in "a bad part of town." Thieves rushed the back of the trailer, cut the lock and opened the door, just in case there was something worth grabbing.

Another, parked overnight with a load of electronics at the southern boarder. He woke up and discovered the trailer had been broken in to. Yet it didn't seem anything was missing. Maybe something "extra" had been placed on the trailer before it crossed in from Mexico?

In our company we're reminded when we'll travel through high theft areas.

If we're pulling a trailer designated as "high value," wherever we are, we're not allowed to pick it up unless we have the fuel and legal hours to go at least 200 miles before we stop.

My vague point is that every security move in history and to come can be defeated, if it's worth it to someone. And it's always with it, to someone.

[BTW, it "feels" unlikely that a judge or jury would convict based on gait analysis.]

[yourapostasy]

> ...filled to the brim with sensors...

Has someone actually worked out that tons of sensors will cost far less than people-driven trucks? As it is, fuel is the big cost, followed by driver salary [1]. L5 autonomous driving is not going to come cheap, that gear is going to price as close to 3X driver salary as they can get away with, on the assumption they can run close to around the clock. Whose margin is getting compressed for the additional sensor gear?

This doesn't even touch upon that as soon as L5 is available and if 24x7 L5 operations approved, you suddenly just increased industry transport capacity 3X, leading to a sudden oversupply in certain segments and scenarios, while still requiring a certain baseline to handle peak load demands. That chaos will cause a lot of margin compression, and lots of rosy profit projections from L5 autonomous driving without drivers will turn into a race for finding more customer demand.

I can see some modest sensor gear, but nothing fancy, and not a lot of them. Perhaps high resolution visual and night vision cameras coupled with lots of street camera access, with lots of back-end software processing will deter most theft attempts?

We might ironically get to L5, only to stick lower-paid security guards on a random number of trucks.

[1] https://www.thetruckersreport.com/infographics/cost-of-truck...

[zjaffee]

There are multiple mile long trains with only 2 people on board at any given time, unmanned trucks won't be a problem as they'd likely travel just travel convoys with a couple people overlooking the fleet.

[pmiller2]

Automated trucks don't necessarily have to be unmanned.

[jandrese]

They do if you are automating them to avoid having to pay human drivers. It's kind of silly to go to all of the effort to automate a truck and then make someone sit on their thumbs behind the wheel for hours on end.

[azinman2]

But why? I would think that trains, which aren’t constrained to gasoline and have dedicated tracks, should be able to obtain higher efficiencies compared to trucks going the same long distances?

[dj-wonk]

Think of shipping as an optimization problem where various modes are selected for different parts of the path. You have to run the optimization problem to see what mix makes the most sense -- and don't expect it to necessarily be simple or obvious.

Logistics is complex; you'll also need to factor many things into the optimization: * both fixed and marginal costs of each mode (e.g. maintaining track, monitoring safety, wear and tear on vehicles, varying fuel costs) * constraints (due to technology, personnel, regulations, etc) * fluctuations in demand and shipping objectives * lots more

If you want to focus on only one slice of the problem... Sure, for the exact same route (meaning that a particular track has already been built), one would expect that trains are more efficient. The data shows that; e.g. https://en.wikipedia.org/wiki/Energy_efficiency_in_transport...

[dwighttk]

you are correct. That's why they don't really compete with each other. You put it on a train for a long distance and then trucks pick it up to spread it out from there.

[dj-wonk]

Sometimes people use "compete" in a casual way that overlooks key economic connections. Competition is a force that is always present, even if it is not currently the "most obvious" factor in play at a given time.

I think any definition of competition must be relative to the sphere of economic activity. So, when it comes to transportation in general, rail and trucks do compete -- by this I mean they offer services with varying prices and characteristics.

Just because rail and trucking have different sweet spots at a particular point in time does not mean that they don't compete. Both (a) think about how and why customers choose them over the other, (b) seek opportunities (for investment or growth) that lead to a competitive edge, and (c) therefore, influence each other.

[rplst8]

> cost cutting is the only way

Not always. If you provide a value proposition that a cheaper offering does not, say speed, you can increase volume.

Highway transportation will not likely get much faster, but high speed freight via rail seems like it might have some room to grow.

[fitchjo]

He is mentioned here pretty regularly, so many may already be aware, but Matt Levine discusses this and its variants a lot in his newsletter, most of the time under the heading "Should index funds be illegal?"

[conanbatt]

Index-funds also have a huge risk: as they become too large, they become distorting how pricing of companies work: i.e. just IPO'ing gets you purchasers.

At some point, the phrase "passive management > active management" will become verifiably false.

[xal]

It takes a long time and after IPO before useful indexes pick you up.

[conanbatt]

A bureaucratic detail.

[akimball]

This comment may explain why we are governed by bureaucracies

[eloff]

This. I haven't heard anybody talking about this before, but it seems like there's an unavoidable tipping point here. I wonder if we've already reached it. Rightly or wrongly I trust my stock picking over an index fund now. At least I can take responsibility for the outcome.

[conanbatt]

I think just as the market will find a balance between passive/active, individual investors will most likely also find benefit in doing part passive part active.

[SilasX]

Why would that matter? If they are obligated by their funds' charters not to intervene, then all the governance decisions happen exactly as if they hadn't invested, right? 10% vs 90% of share votes being on auto-pilot shouldn't matter?

Is the argument that the vast majority of them could change their funds' charter to allow them to be actively involved with governance? If so, that would be really hard to achieve even if many of them worked at it.

Edit: three people have made the same "it's easier to get a controlling interest" argument. See my reply in the follow-up before making another redundant comment.

[avisser]

> 10% vs 90% of share votes being on auto-pilot shouldn't matter?

I'm not familiar with these non-intervention clauses, but in the 10/90 scenario haven't you made it much easier to seize control of the company? Now I only need 5%+1 of the shares to do as I wish?

[everdev]

Or, it's easier to pass things with a shareholder vote because the index funds won't vote.

[timerol]

If 90% of shares are non-intervening that means hostile takeovers are now 10x cheaper to implement. It would be weird to be a company with market cap $100M, where $10M could buy a controlling interest in voting shares.

[Hermel]

Non-intervening usually means the vote according to the recommendations of the board, and not that they abstain from voting.

[AnthonyMouse]

That seems like a different kind of problem though. If funds that vote according to the recommendations of the board own >50% of the company, the board becomes unaccountable. (Unless they apply different rules to board elections, but then we're back to the original problem because the minority activist can elect their own board.)

[jandrese]

This seems to be mostly in keeping with the spirit of index funds. It's a hands off approach that lets the company run itself.

In theory an index fund should never own that much of a company, because that means it would own >50% of all publicly traded companies. The whole point is to spread the risk evenly so you can realize the average returns without having to put any thought into it. It shouldn't mean it's buying $100k shares of GE and also $100k shares of Mom&Pop Pickle Fork Inc.

[gbear605]

But if all the index funds together own >50%, and they all go with the board, then it's the same as if it was a single company that went with the board.

[dragonwriter]

> If 90% of shares are non-intervening that means hostile takeovers are now 10x cheaper to implement.

Naively (ignoring other dynamics of index funds), sure, compared to 100% investors actively engaged in governance. But I suspect investment in index funds replaces largely hands-off direct investment and so, market wide, has virtually no average effect on that (though it may shift the effect among firms compared to those investors doing so directly.)

[everdev]

You also can't determine which 5% you're buying on the open market. You might just be buying shares sold by index funds.

[garmaine]

Only if you ranked the price by buying shares. But even if that’s as the case the. The threshold is 10% not 5%. Point still stands.

[SilasX]

It's not any easier (to a first approximation), because the share price will increase as you try to buy in, and the lower fraction of actively traded shares makes them that much more scarce and ramp up in value that much more quickly.

[walrus66]

To expound what you're suggesting, which is completely ridiculous, is that if someone buys 5.1% of actively traded float, the price will exponentially surge such that it would be equivalently priced to purchasing 51% of float in a market without a 90% passive stake.

[AnthonyMouse]

Not only that, it doesn't account for short sellers. Index funds will happily lend their "passive" shares to anyone (i.e. short sellers) willing to pay interest. So if prices start to rise as someone tries to buy 5%+1 of the shares, others will rightly determine that the shares are now overvalued and start selling them short (especially if the buyer is expected to harm the company), allowing the buyer to keep buying at a minor premium over the original price. Or even at a discount, if the purchase is seen as inevitable and the damage they're expected to do gets priced in.

[thisisit]

> then all the governance decisions happen exactly as if they hadn't invested, right? 10% vs 90% of share votes being on auto-pilot shouldn't matter?

If that was the case it would have been easy. Handful of people fighting for power.

But from what I can read the problem is exactly the opposite. As someone said below that Blackrock has been known to rubber stamp executive salary and maybe others follow suit. What is then stopping companies from going bigger and bigger on executive salary knowing that they will get rubber stamped from the funds?

What happens if there is a complex governance issue which requires vote and the index fund lack the motivation to ensure that they have weighed all the decisions correctly?

[Misdicorl]

Much easier for other parties to get a controlling interest if you need 5.1% of the stock compared to 50.1%

[walrus66]

Ignoring the obvious controlling interest issues which others have mentioned, which is the largest issue...

That's a funny contradiction of a sort - then the index fund becomes the agent it's supposed to be observing.

For one, Blackrock is not Berkshire Hathaway - and in reality, obviously Blackrock can't wake up tomorrow and decide to be. They're not built for that.

Another scary thing is that the market is being increasingly turned into a derivative, and the underlying asset becomes more volatile (certainly for many different reasons) as it becomes proportionally smaller .

[yourapostasy]

Bogle has gone on record that he believes the market efficiency limits of passive indexing are somewhere in the 70-90% range of equities held inside such broad market indexes [1]. A more reasonable and less click-baity headline would have been "Bogle Sounds Governance Warning on Index Funds".

[1] https://www.ft.com/content/4594f554-ba1a-11e7-9bfb-4a9c83ffa...

[mcguire]

How do these financial institutions vote their shares?

[soVeryTired]

Blackrock have a history of rubber-stamping executive pay packages. In the past, they've voted in favour of proposed CEO pay packages in something like 99% of cases. Some people have argued that doing so benefits Blackrock execs themselves because high pay then becomes the norm.

https://www.pionline.com/article/20170418/ONLINE/170419868/b...

[walshemj]

Which is why I preferer UK Investment Trusts I can vote on the board and their remuneration.

[swarnie_]

Most vote with the board on all matters.

The only large fund i know that regularly gets its hand dirty is the Norwegian sovereign wealth fund.

[zimablue]

A lot of them outsource voting decisions to companies which exist just to aggregate the most "corporate/sensible" way to vote. So the parent saying "they're not activist investors" is probably true, but then every single vote proceeding along "maximise profit according to a consensus view" lines probably isn't great for society.

[wbl]

They follow ISS or similar.

[akimball]

The international space station? Islamic state in Syria?

[sseveran]

I have a hard time seeing it as unintended. If you are not promising any differentiation between yourself and the index than the only thing to really compete on is cost. There are economies of scale in finance, specifically if you need to optimize solely for AUM.

[davio]

There's definitely a race to the bottom going on with the free Fidelity funds and Vanguard reducing the dollar minimum by 70% for a lot of admiral shares.

[refurb]

Yet another great example of "race to the bottom" benefiting consumers. Not sure why it's used in a negative way all the time.

[pmiller2]

It's used in a negative way all the time because the people using it are usually on the losing end of the deal.

[thisisit]

Because eventually businesses wake up to the fact that they need to make money. And they do it by going the absurd route.

For example, online help is free but if you need to talk to a human being support, give us $10 a call or something. And while an average consumer might not be affected, people who are actually affected end up a nightmarish situation.

[refurb]

But that's just running a business poorly and you'll likely lose customers over it.

[barrow-rider]

Vanguard is doing "Auto" Admiral too -- if you meet the 3k minimums for Admiral funds they're auto converting you anyway.

Race to the bottom or not, competition works.

[xkjkls]

Yeah, it's not surprise that corporate governance is at its worse state in decades. Too many companies have boards filled with management sycophants who never due real work in guiding corporations in the interests of shareholders.

[gammateam]

> but that their popularity is leading toward a handful of financial institutions holding controlling interests in most of the largest companies.

Which allows for them to do things like demand publicly traded recruit women to their boards. Which is a useful talent when you are focused on economic growth, and your holdings are focused on extreme paper-meritocracy that fails to result in actually addressing additional portions of a market because their talent pool can't perceive it.

https://newsroom.statestreet.com/press-release/corporate/sta...

oh no the potential.

[dasil003]

Right, because when shadowy groups get unimaginable leverage and power the first thing they do is apply affirmative action pressure to address gender imbalances.

[gammateam]

> Right, because when shadowy groups get unimaginable leverage and power the first thing they do is apply affirmative action pressure to address gender imbalances.

Yes, that is exactly what happened, dasil003

https://newsroom.statestreet.com/press-release/corporate/sta...

State Street has 2.7 Trillion AUM

[whatok]

State Street also used that as a marketing stunt to launch an ETF while they were being sued for sexual harassment and pay discrepancies between male and female employees. Marketing is marketing is marketing.

[gammateam]

yes, and also 300 companies added female directors

nothing exists in a vacuum

[whatok]

Nothing exists in a vacuum just like solely attributing companies adding female directors to a marketing stunt. There was large momentum on this front already that would have happened with or without this.

[thisisit]

> A bit click-baity, but the warning here from the father-of-index-funds is not that they've become a bad investment

I really doubt that he will ever come out and clearly say that they've become a bad investment.

But the insinuation is that going forward index funds might cause harm to public's interest. And law makers need to come up with laws to ensure that doesn't happen.