Many Prices for the Same Index

Leggio: I thought we could take a moment and look at one subset of funds specifically to figure out if it demonstrates that the industry is competitive or not.

Both of you are looking at our latest data on index fund fees. As you note in your law review article, Professor Coates, the majority of assets of index funds are in the lowest cost providers, and the data bears that out. The Vanguard 500 Index Fund has somewhere around $85 billion in assets, and the two other low cost funds, Fidelity has $13 billion, and Schwab has $6 billion.

Professor Coates, my question centers around two other funds that you see in this data table. If we assume that the T. Rowe Price Equity Fund is run at at least a small profit, you have $2.3 billion going into a fund which charges almost twice as much in the Dreyfus Fund and the BlackRock Fund, which has $1.6 billion.

In a competitive marketplace, we normally wouldn't expect investors to tolerate paying upwards of two or three times as much for basically a commodity product. Doesn't this data really suggest that there really are some issues and some circumstances with a competitiveness in the industry?

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Coates: No, I don't think it does. It's possible. I haven't looked at the facts of those particular fund complexes. It's possible that shareholder plaintiffs might be able to make out a case that the funds there are overcharging their customers.

But one thing to bear in mind is that when you choose a fund, at least when most investors, I think, choose funds, they're choosing a complex as well, and therefore the right benchmark in thinking about potential dispersion across funds even within the index universe is not simply at the fund level but also at the complex level.

So just to give a homely metaphor here, when I take my car into the Volvo dealer to have it serviced, I pay them to wash it for me. They overcharge me in some narrowly defined, strict sense of the washing cost when I have them do that, but it's convenient for me because I can get it done simultaneously and I can save costs by doing it.

If you look at the add-on cost for the washing there, they're having somebody who's doing it probably a little better than you could get it done down the street at the standalone auto wash. But combined, I'm happy to pay the total service because I'm getting a blended product across the whole complex that is in fact good for me.

And I have no reason to think that the customers of T. Rowe Price and BlackRock--and I don't think you do either--are somehow fooled into overpaying for their index fund fees. These are very easy to find out. You can find it out in three clicks on Morningstar. If they wanted to move their money and save whatever tiny fraction of a penny that it adds up to over time, they could do that.

Leggio: Professor Birdthistle, do you agree?

Birdthistle: I think it's possible that those are reasons why people are overpaying for those funds. I don't think there's any evidence of it beyond speculation that it's possible. I think if these are platforms where people can move in and out between funds and there's no reason to be obliged to stay with one fund family for all of your funds, very few people do that as far as I know. Most people have a broad mix of investments.

So there's also no real impediment to switching back and forth. The fact that they don't, I think is troubling. Yeah, broad price dispersion of 1, 2, 3, 500% in the same commodity product, that's troubling. That violates the law of one price in basic economics. There are reasons why it might be happening, as Professor Coates speculated, but I haven't seen any evidence of why it's happening.