Morningstar Magazine - December 2017/January 2018 - 19

Index funds have forced active funds to justify
their higher fees and explain their strategies. They
have put plan sponsors and IRA advisors under
pressure to ensure they recommend active funds
whose fees they can justify to their clients.
Indeed, the asset-weighted average expense ratio
for all funds fell to 0.57% in 2016, down from
0.61% in 2015 and 0.65% three years ago,
according to Morningstar's latest fees study
(Oey 2017). The asset-weighted average fees for
passive funds and active funds are 0.17% and
0.72%, respectively, according to our fees study.
If index funds could no longer operate as
they have, but had to pick which companies to
invest in, what would the ripple effects be for
investors? Keep in mind that the low costs of index
funds are directly related to their simplicity.
Add another layer of stock selection to the process
of indexing, and investors can expect fees
to go up.
Other Explanations for Abnormal Profitability

In terms of the anticompetitive effects of
common ownership, how strong is the available
evidence, and where can we look for other
proofs? What other explanations might there be for
the abnormal profitability of publicly traded
companies we have seen? And how can we drill
down to the total costs of these anticompetitive
effects, if there indeed are any?
As you'll read in this issue's Spotlight
section, Morningstar's analysts have found
evidence as to why companies have
become abnormally profitable recently. There are
more wide-moat companies today than in
the past. These firms operate in industries with
a high barrier to entry and, thus, can charge
higher prices. Or maybe, U.S. industries
have become less competitive as fewer publicly
traded companies compete against each other.
(Such a problem suggests more traditional
antitrust solutions.)
In other words, there is not conclusive evidence
that asset managers with too much concentrated
ownership are the problem-yet. That does
not mean this could not become a problem in the
future. I merely mean that we don't have
enough evidence to link the cause of higher-thannormal profitability to the anticompetitive

effects of asset managers owning large shares of
competing companies, rather than to other trends.
Finally, to properly perform a cost-benefit analysis
on restricting mutual funds from common
ownership of competing firms, we would need
a clear empirical estimate of the costs to
consumers. In the airline industry, Azar et al.
estimate common ownership costs consumers an
extra 3% to 7% in ticket prices. But what about
other industries? And Azar's airlines estimate
is a wide range. The two ends of the range
(3% and 7%) might yield different answers to a
cost-benefit analysis, given the importance
of index funds to a broad range of ordinary
retirement savers.
Break Up Index Funds?
It seems unlikely that U.S. policymakers are

going to act on any of these ideas now, but that
might change the next time Democrats are
ascendant. A key centerpiece of their plan is the
"Better Deal on Competition and Costs," which
promises to "crack down on corporate monopolies."
There are two big reasons this line of argument will
make for appealing rhetoric in the midterm
elections and beyond. First, as income and wealth
inequality has grown, there is a growing belief
that the system is rigged, so running against
monopolies is a good way to align that feeling with
concrete policies.
Second, antitrust action allows politicians to talk
about increasing equality without arguing
for massive new bureaucracies, raising taxes, or
redistributing resources in obvious ways.
The Better Deal plan does not mention asset
managers but focuses instead on the usual
suspects: airlines and cable and telecom
companies, along with less-frequently talked about
industries such as breweries and commercial
agricultural seed companies-examples that seem
crafted to appeal to Americans living in the
heartland. However, most legislation tends to give
broad statutory authority to regulators, who
can fill in the details later.

a new consumer competition advocate, with
broad authority to keep markets fair and open.
Given the academic literature on common
ownership among asset managers of competing
companies, this could pave the way to new,
novel forms of antitrust action, effectively ending
broad index funds, thus raising the costs
(and lowering the returns) of ordinary investors.
Furthermore, high-profile Democratic senators
(Cory Booker, Amy Klobuchar, Kirsten Gillibrand,
and Al Franken, among others) are taking
the idea seriously and recently introduced a bill
(S. 1811) that would require the Federal
Trade Commission to study whether common
ownership of companies by asset managers
affects competition.
Evidence Needed Before Action

None of this is to say we should not treat
arguments about concentrated ownership
seriously. As the great political theorist Albert O.
Hirschman argued in The Rhetoric of Reaction,
people opposed to policy reforms have
argued for centuries that a reform will perversely
result in the opposite effect of what policymakers wish or jeopardize a positive status quo.
The questions raised in this article could be viewed
as an endorsement of the status quo. On the
other hand, we prefer to err on the side of
the known advantages of index funds, as opposed
to the putative gains from their disruption,
until there is more evidence to resolve the key
questions around the costs and benefits of
a policy response. K
Aron Szapiro is director of policy research with Morningstar.
References
Azar, J., Schmalz, M., & Tecu, I. 2017. "AntiCompetitive Effects of Common Ownership," Journal
of Finance, forthcoming.
Campbell, J.Y., Lettau, M., Malkiel, B.G., & Xu, Y. 2001.
"Have Individual Stocks Become More Volatile?
An Empirical Exploration of Idiosyncratic Risk," The Journal
of Finance, Vol. 56, No. 1, February, pp. 1-43.
Oey, P. 2017. "U.S. Fund Fee Study," Morningstar Manager
Research white paper, May 23.
Posner, E., Morton, F.S., & Weyl, E.G. 2017. "A Proposal
to Limit the Anti-Competitive Power of Institutional
Investors," Antitrust Law Journal, forthcoming.

In this case, should the Better Deal plan turn into
legislation and eventually law, it would create

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Table of Contents for the Digital Edition of Morningstar Magazine - December 2017/January 2018