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ETF Specialist

Much Ado About Nothing: The Impact of Diversified Funds on Competition

A new line of research suggests that diversification across stocks in an industry can reduce competition, but that argument is weak.

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Does common ownership of stocks in the same industry reduce competition? That is the central question that an emerging body of academic research is seeking to address. While this research is still in its early stages and the evidence is inconclusive, the policy reactions it might elicit could be significant for investors.

Some proposals have suggested limiting an asset manager's holdings to one stock in each industry where its ownership stake in a firm exceeds 1%, which would effectively ban large index funds, and preventing asset managers that own two or more competitors from exercising their voting rights. (Morningstar's Aron Szapiro explains why these policy recommendations are problematic in his article, "Would Policymakers Target Index Funds?") But the underlying argument that common ownership leads to less competition relies on some misguided assumptions.

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Alex Bryan does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.