[cma]

Shareholders of the ETFs. Again, I'm not saying this specifically actually happens in the case of Vanguard, but all kinds of other conflicts of interest like this happen all the time, and reporters should be ever skeptical, and not just report he-said she-said, "oh Vanguard says they got this covered."

[jsprogrammer]

How do they lose though? In higher fund expenses or reduced NAV because the actions reduced the index?

[cma]

On Monday an index is made up of 100% MSFT, and it announces that on tuesday the index will be rebalanced to 100% APPL. The index has ETFs tracking it that are large enough to exhaust the availability of liquidity in both MSFT and APPL during a quick rebalance. Eventually over time the liquidity arrives to correct the mispricing, valuing things based again on underlying fundamentals. Both the index and the shareholders of the ETFs take a hit as the price of MSFT rises (no longer part of the index) and APPL (part of the index) lowers back down to normal, assuming no changes in fundamentals in the meantime.

The ETFs can be smart about it and try and make the trades over time instead of all at once, and Vanguard likely does. This then feeds back in and lowers the amount that the actual index takes a hit. The equilibrium in reality is that both the indexes and the shareholders in the ETFs take a bit of hit.