Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 220

The truth on three big indexing questions

Indexing has become an undeniable force in the investment world. Consider that US$1.4 trillion in net new cash and reinvested dividends flowed into US equity index funds and ETFs in the decade through year-end 2016, which is astonishing compared with the US$1.1 trillion in net outflows from active funds in the same period.

Indexing’s rise did not happen by accident. At Vanguard, the improvement in index fund management included refining index sampling techniques, better approximating the fundamental characteristics of benchmarks, working closely with benchmark providers and strengthening index methodologies.

But the push to improve indexing does not stop there. In my new role as Vanguard’s Chief Investment Officer, my global team and I are dedicated to staying abreast of new themes in the investment world, especially exploring the details of what makes indexing tick. Our mission is to optimise the investment outcomes for our clients and investors overall at a low cost.

I am a firm believer in the value indexing delivers to both the investor and the market as a whole. But over the last few months, indexing has received criticism from a few commentators alleging indexing hurts price discovery, stifles competition via common ownership, and leads to higher volatility. I believe those claims are inherently false, so let’s walk through these arguments and set the record straight.

1. Does indexing hurt price discovery?

The concern about indexing hurting price discovery is naive. Price discovery is driven by active managers, Vanguard included. I know from my years as a bond guy the vital role that active managers play in keeping security prices aligned with their value. The thought that indexing could somehow get in the way of that is troubling for me. But the truth is that even though indexing has grown in popularity, it’s still a small part of overall trading volumes (i.e. portfolio managers’ trading of index funds’ underlying securities). Since indexing represents about 5% or less of US equity daily volumes, as shown in the chart below, there is still considerable price discovery and liquidity provided by active managers.

Breakdown of overall individual stocks’ trading volume

Sources: Vanguard and Bloomberg, 2017.

2. Does indexing cause a lack of competition?

Critics claim that managers of corporations whose stocks are in some of the leading indexes become complacent participants, rather than competitors, because stock prices are propped up by the steady drumbeat of index investments. There is no evidence to support these anticompetitive practices or that there is a cause-and-effect relationship between common ownership and product price competition. All the corporate executives that I know are diehard competitors and are doing everything in their power to expand market share, increase revenues, and boost profits.

In addition, as owners of just about every company in every industry, index funds have no incentive to favour one industry over another as higher product prices in any one industry would cut against fund investors’ interests in other sectors.

We believe fierce industry competition produces greater shareholder return and a healthier industry as a whole, since competition forces companies to constantly innovate and find new ways to deliver value to both consumers and shareholders. We firmly believe the best performers should be rewarded, which is why we advocate for executive compensation plans to be tied to performance, not stock price, and have explicitly promoted competition among firms in their respective peer groups.

3. Does indexing drive volatility?

I do not see any substance to the concern that equity index funds contribute to market volatility. Regardless of size, indexing is not a monolithic investment strategy. Index investments are spread through many market caps and investment styles, and the majority of index assets are held by long-term investors in broad-based, market-cap-weighted funds. There is no convincing evidence that the growth of index funds has had an impact on market volatility or the dispersion of stock returns. Even as index funds’ share of mutual fund assets has consistently grown, market standard deviation has risen and fallen in a seemingly random pattern. Dispersion among the stock market’s securities has remained somewhat constant, except for the tech bubble and the global financial crisis.

The real truth: indexing has earned its accolades

Indexing has transformed the investment experience for millions of investors. We take pride in the fact that we have helped investors enjoy the many benefits of indexing, including:

  • Low cost
  • Broad diversification
  • Relative predictability
  • The potential for long-term outperformance compared with the performance of many high-cost active fund managers.

Indexing offers a firm foundation for investors seeking to achieve their investment goals, and as Vanguard’s CIO, it’s my job to make sure that indexing and active management continue their symbiotic relationship in the investment landscape.


Greg Davis is the Vanguard Group’s Global Chief Investment Officer. This article is general information and does not consider the circumstances of any individual.


Everything my friends need to know about investing

Howard Marks asks 5 questions on indexing


Most viewed in recent weeks

10 reasons wealthy homeowners shouldn't receive welfare

The RBA Governor says rising house prices are due to "the design of our taxation and social security systems". The OECD says "the prolonged boom in house prices has inflated the wealth of many pensioners without impacting their pension eligibility." What's your view?

Three all-time best tables for every adviser and investor

It's a remarkable statistic. In any year since 1875, if you had invested in the Australian stock index, turned away and come back eight years later, your average return would be 120% with no negative periods.

The looming excess of housing and why prices will fall

Never stand between Australian households and an uncapped government programme with $3 billion in ‘free money’ to build or renovate their homes. But excess supply is coming with an absence of net migration.

Five stocks that have worked well in our portfolios

Picking macro trends is difficult. What may seem logical and compelling one minute may completely change a few months later. There are better rewards from focussing on identifying the best companies at good prices.

Let's make this clear again ... franking credits are fair

Critics of franking credits are missing the main point. The taxable income of shareholders/taxpayers must also include the company tax previously paid to the ATO before the dividend was distributed. It is fair.

Welcome to Firstlinks Edition 424 with weekend update

Wet streets cause rain. The Gell-Mann Amnesia Effect is a name created by writer Michael Crichton after he realised that everything he read or heard in the media was wrong when he had direct personal knowledge or expertise on the subject. He surmised that everything else is probably wrong as well, and financial markets are no exception.

  • 9 September 2021

Latest Updates

Investment strategies

Joe Hockey on the big investment influences on Australia

Former Treasurer Joe Hockey became Australia's Ambassador to the US and he now runs an office in Washington, giving him a unique perspective on geopolitical issues. They have never been so important for investors.

Investment strategies

The tipping point for investing in decarbonisation

Throughout time, transformative technology has changed the course of human history, but it is easy to be lulled into believing new technology will also transform investment returns. Where's the tipping point?

Exchange traded products

The options to gain equity exposure with less risk

Equity investing pays off over long terms but comes with risks in the short term that many people cannot tolerate, especially retirees preserving capital. There are ways to invest in stocks with little downside.

Exchange traded products

8 ways LIC bonus options can benefit investors

Bonus options issued by Listed Investment Companies (LICs) deliver many advantages but there is a potential dilutionary impact if options are exercised well below the share price. This must be factored in.


Survey responses on pension eligibility for wealthy homeowners

The survey drew a fantastic 2,000 responses with over 1,000 comments and polar opposite views on what is good policy. Do most people believe the home should be in the age pension asset test, and what do they say?

Investment strategies

Three demographic themes shaping investments for the future

Focussing on companies that will benefit from slow moving, long duration and highly predictable demographic trends can help investors predict future opportunities. Three main themes stand out.

Fixed interest

It's not high return/risk equities versus low return/risk bonds

High-yield bonds carry more risk than investment grade but they offer higher income returns. An allocation to high-yield bonds in a portfolio - alongside equities and other bonds – is worth considering.



© 2021 Morningstar, Inc. All rights reserved.

The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.