“At current rates of asset inflows, it will not be long before index funds effectively control Corporate America and the corporations of many foreign countries,” [Pershing’s Bill] Ackman writes. “The Japanese system of cross corporate ownership, the keiretsu, has been blamed for decades of Japanese corporate underperformance and economic malaise. Large passive ownership of Corporate America by index funds risks a similar outcome without the counterbalancing force of large active investors and improvements in the governance oversight implemented by passive index fund managers.”
Ackman’s main argument – and it’s a common knock on standard-issue market-weighted index funds – is that a purchaser is buying inherently overvalued stocks.
“As more and more capital flows to index funds…the valuation of the indexed constituent companies increases,” he writes. “While some investors consider the valuation of the index components when allocating to specific index funds, many and perhaps most do not.”