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Vanguard Has No Worries About Growth of Indexing

Christine Benz

Note: This video is the first of a six-part interview between Morningstar director of personal finance Christine Benz and Vanguard president and CEO Tim Buckley.

Christine Benz: Hi, I'm Christine Benz for Tim Buckley ascended to the role of president and CEO at Vanguard earlier this year. He is with me to discuss the state of the state at Vanguard today as well as to discuss the firm's future direction.

Tim, thank you so much for being here.

Tim Buckley: My pleasure, Christine.

Benz: Tim, let's talk about the growth of indexing at large. We've obviously seen huge inflows into index funds and ETFs, not just at Vanguard but throughout other firms as well. There has been a lot of handwringing since this trend has been playing out that we might start to see indexing pervert market behavior that we may start seeing markets perform in different ways because of a lot of money going into stocks without a strong intention to be in a specific company. Let's talk about that. What's your view on that?

Buckley: Christine, when we hear those things, those people are often using the wrong lens. You look at mutual funds, yes, indexing has started to dominate mutual fund flows and mutual fund assets. Think about mutual fund assets on the whole, index funds make up about 30% of mutual fund assets. It's a sizable portion of mutual fund assets. But if you look at investable assets, if you look at the markets, indexing makes up 10% of the market overall. If you look at trading in the equity markets, it's 5%. If you look at market cap in the equity markets, it's 15%.

If you just look at the equity markets where people are often worried about pricing and price discovery, at most, indexing makes up 15% of assets. Pricing is about trading. Price discovery, it's trading, it's two people disagreeing, 95% of the trading that goes on, it's done by active managers. Active managers, high-frequency traders, people looking for that price discovery; only 5% of it's driven by mutual funds. That's hardly going to distort anything. We are a long way from potential distortion. I think people are worried about nothing there.

Benz: How large would indexing have to grow in your view to begin to have a meaningful impact on how the market in aggregate behaves?

Buckley: You'd have to see it start to make up the lion's share of trading where--indexing is really, you are just buying what the market believes that price to be. As long as you have two people disagreeing, one who is buying and one who is selling, of the value of something but they eventually meet on a price, you are setting a price that's going to clear the market. How many people do you need to do that? It's an academic argument right now. If 95% of the market is doing it right now, I don't think we need to worry. If we get toward the lion's share of people waiting for that price to be set, then maybe we'll worry. But we are long away from that.