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How trillion dollar stock market index funds are vulnerable to manipulation that 'could harm American investors'

Dangers may lurk in index funds, a popular area of ​​the stock market known for its recent and consistent record of outperformance against actively managed funds, according to experts.

A recent op-ed in the New York Times cautions that passive index funds may be vulnerable to bias and possibly manipulation, as interest in those funds has ballooned over the past decade.

Read: Opinion: Why the 'mania' for index funds does not want the stock market

This is how Robert J. Jackson, Jr., is a member of the Securities and Exchange Commission, and Steven Davidoff Solomon, a professor at the University of California, Berkeley, Law School published Feb. 1

8 in the New York Times:

But there's a problem: The indexes these funds are based on may not be as neutral as they are. The firms said they were unable to protect themselves from the risk. "

For instance, MSCI added pressure from the Chinese government.

Jackson Jr. and Solomon added in the Times article:

Conflicts of interest should worry anyone who is invested in index funds, which includes many Americans with retirement accounts. Index providers have enormous power. The decision to include a company in the S & P 500, for example, results in a reallocation of dollars of investors' money. The average company added to the S & P 500 gains value; when it's removed, its share price drops as index funds sell their holdings.

By the way, the Dow Jones Industrial Average

                                     DJIA, + 0.03%

and the S & P 500 index

                                     SPX, + 0.15%

for example. Those include, passive ETFs like the SPDR Dow Jones Industrial Average ETF Trust

                                     DIA, + 0.06%

known by its ticker "DIA," and the SPDR S & P 500 ETF Trust

                                     SPY, + 0.17%

known as "SPY," for example.

Active management had become the standard on Wall Street, and it was tremendously popular in the dot-era era, when high flying internet stocks minted star money managers. However, in the current expansion, the old order has become obsolete by passive vehicles-perhaps forever.

Interest and money flows have grown because of both outperformance against their actively-traded counterparts, like hedge funds and mutual funds, and their relatively low costs. Search Passive ETFs track to benchmark and simply reflect its moves. Search passive investing, as Morningstar has put it, in a report last summer, have "failed to survive and beat their benchmarks, especially over longer time horizons,"

Morningstar says the growth of ETFs has been driven by this massive shift to passive investing, with the likes of Vanguard, founded by John Bogle. and Black Rock

                                     BLK, -0.20%


According to Morningstar, total assets in U.S. Pat. mutual funds and ETFs reached a record of just over $ 18 trillion, at the end of 2017, a tripling of assets from $ 5.5 trillion just nine years ago. Nearly $ 6.7 trillion, the data provider said.

To be sure, not everyone agrees with the views shared by Jackson Jr., and Solomon.

"Hard to imagine an investment more transparent than index funds that publish holdings and rule on a daily basis. Investors want to understand what's inside. Todd Rosenbluth told MarketWatch via email on Tuesday. "CFRA Research Director of ETF & Mutual Fund Research.

Rosenbluth said examples offered by the authors in the Times op-ed "Do not go to apply … to plain vanilla funds."

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