Yeah, it’s definitely flawed. I was more thinking that the bids could be made as a difference between an index (probably a global one). So the profit-maximizing bids for the funds would be the index return (whatever it happens to be) minus their expected costs. And then you have large underwriters of the firms, who make sure that the fund’s processes are sound. What I’d like is everyone to be in Vanguard/Blackrock, but there should be some mechanism for others to overthrow them if someone can match the index at a lower cost.
Yeah, that’s right. The problem with my toy model is that it assumes that funds can actually estimate their optimal bid, which would need to be an exact prediction of the their future returns at an exact time, which is not possible. Allowing bids to reference a single, agreed-upon global index reduces the problem to a prediction of costs, which is much easier for the funds. And in the long run, returns can’t be higher the return of the global index, so it should maximize long-run returns.
However, most (?) indices are made by committees, which I don’t like, so I wanted to see other people’s ideas for making this workable. (But index committees are established and seem to work well, so relying on them is less risky than setting up a brand-new committee as proposed in that government report.)
My understanding is the committees generally make rules for the indices, and then apply them relatively mechanistically, though they do occasionally change the rules. I think it is hard to totally get rid of this. You need some way to judge that a company’s market cap is actually representative of market trading, as opposed to being manipulated by insiders (like LFIN was). Presumably if the index committee changed it to something absurd the regulator could change their index provider for the next year’s bidding, though you are at risk of small changes that do not meet the threshold for firing.
As a minor technical note gross returns often are (very slightly) higher than the index’s, because the managers can profit from stock lending. This is what allows zero-fee ETFs (though they are also somewhat a marketing ploy).
Yeah, it’s definitely flawed. I was more thinking that the bids could be made as a difference between an index (probably a global one). So the profit-maximizing bids for the funds would be the index return (whatever it happens to be) minus their expected costs. And then you have large underwriters of the firms, who make sure that the fund’s processes are sound. What I’d like is everyone to be in Vanguard/Blackrock, but there should be some mechanism for others to overthrow them if someone can match the index at a lower cost.
Ahhh, so basically the idea is that no underwriter would be willing to vouch for anything but a credible index shop. Seems plausible.
Yeah, that’s right. The problem with my toy model is that it assumes that funds can actually estimate their optimal bid, which would need to be an exact prediction of the their future returns at an exact time, which is not possible. Allowing bids to reference a single, agreed-upon global index reduces the problem to a prediction of costs, which is much easier for the funds. And in the long run, returns can’t be higher the return of the global index, so it should maximize long-run returns.
However, most (?) indices are made by committees, which I don’t like, so I wanted to see other people’s ideas for making this workable. (But index committees are established and seem to work well, so relying on them is less risky than setting up a brand-new committee as proposed in that government report.)
My understanding is the committees generally make rules for the indices, and then apply them relatively mechanistically, though they do occasionally change the rules. I think it is hard to totally get rid of this. You need some way to judge that a company’s market cap is actually representative of market trading, as opposed to being manipulated by insiders (like LFIN was). Presumably if the index committee changed it to something absurd the regulator could change their index provider for the next year’s bidding, though you are at risk of small changes that do not meet the threshold for firing.
As a minor technical note gross returns often are (very slightly) higher than the index’s, because the managers can profit from stock lending. This is what allows zero-fee ETFs (though they are also somewhat a marketing ploy).