by Sean Kelly

Index funds are a form of passive investing that track a broader index, like the S&P 500 which houses the stocks of 500 large-cap U.S. companies including Apple, Microsoft, ExxonMobil, Johnson & Johnson, General Electric, Amazon and Facebook. They’re low-cost and relatively uncomplicated investments that can take the form of a mutual fund or an exchange-traded fund (ETF). They’re based upon a pre-set bucket of stocks that are aligned to an index — and for the first time in history their cumulative value has surpassed managed stock holdings.

The rise of indexing has been propelled by their one-stop shopping convenience which saves time, research hours, and the need for a portfolio manager and their associated fees. And, since most indexes include an array of diversified companies, they’re generally considered low risk. Their ease and simplicity are so appealing that, they’ve invaded Wall Street, particularly since the financial crisis and according to Reuters now control half of the mutual fund market. The Vanguard S&P 500 ETF, one of the largest funds on record, was sitting on $520 billion in assets as of December.

“The index fund is one of a handful of unambiguously beneficial financial innovations. Before it caught on, investors routinely paid sky-high fees to active stock-pickers who often delivered subpar returns. The near-universal popularity of index funds puts them up there with Social Security, Stevie Wonder, and streaming TV.” Bloomberg

Over the past decade some $1.36 trillion has been dumped into indexed mutual funds and ETF’s — while some $1.32 trillion was subsequently pulled out of traditionally managed accounts. The Wall Street Journal calls it, “the passing of the asset crown” and “one of the most dramatic transformations in the history of the financial markets.”  But while the seismic shift has increased fund access and lowered the cost of investing, it has also dramatically consolidated power within the industry as indexing goliaths Black Rock, Vanguard and State Street are now the largest shareholders in almost 90% of S&P 500 firms. Similarly, Barron’s reports that the three firms hold 80% of ETF assets in some 600 products, “that leaves another 1,600 ETFs and more than 100 firms competing like gunslingers in the Wild West.”

The Securities and Exchange Commission approved the first ETF in 1993 and according to the Washington Post there were only 124 index funds back in 1996 valued at just $100 billion. According to recent estimates, the number of ETF’s and Index Funds has now climbed to over 2,000 with a combined value nearing $7 trillion. Their growth shows no sign of slowing down as Black Rock recently estimated the total value of indexing could reach $12 trillion by 2025.

The SEC is now asking some pointed questions, however about transparency, market stability, and the consolidation of financial power. There is little regulatory oversight of the firms that create these indexes, and they’re more than ripe for conflicts of interest. And, while there is a collective upside to indexing during a rising market, the funds offer scant protection for a sudden sell-off or consolidated stampede. Further, retirement funds and life savings are subject to the amalgamated whims of the three, giant asset managers: BlackRock, Vanguard and State Street, the index cartel — subjecting millions of Americans to an uncharacteristic loss of control with respect to their money and retirement savings.

And there are other concerns. The sheer size and number of these funds could distort market prices and make the exchanges unstable. The frenzy surrounding passive investing is reminiscent of bubble behavior and that could cause a market collapse when the inflows exhale. And lastly, these funds offer no allowance for personal risk tolerance or an asset mix that reflects specific retirement needs.

Even the late, great Jack Bogle, the founder of Vanguard and the ‘Father of Indexing’ mused as recently as last year that there are too many shares in too few hands – and that could undermine investing behavior and disrupt market metrics. The truth is Index Trading is too vast to stop, too large to curtail, and far, far too big to fail. But what if it does?

Indexing can mask a multitude of hidden dangers and this is precisely where an alternative investment outside the mania of fast-shifting barometers becomes critical. Gold is private, confidential, highly liquid, and carries no counter-party risk. It is the ideal ‘check and balance’ asset to protect our money from those things beyond our control, specifically — the new world dominance of index funds and the new power brokers of Wall Street.

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