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Wednesday, November 29, 2017

Is Indexing Distorting Prices?

News summary by MFWire's editors

For the second time in 2017, Barbara Novick is publicly defending index funds and ETFs via the Wall Street Journal's opinion page. This time she's tackling a different indexing worry: how indexing affects stock price momentum.

Earlier this week Novick, co-founder and vice chairman of BlackRock (whose iShares unit is the world's biggest ETF shop), wrote in the WSJ to push back against fears that the massive flows going into indexed asset management products are distorting prices in the stock market. The commentary piece comes ten months after Novick wrote in the WSJ to counter a criticism that indexing "discourages competition among the companies in which the funds invest."

In her new piece, Novick points out that, despite index funds' dominance of net flows, four-fifths of global equities are still actively managed (by asset managers or directly by investors). Furthermore, those active investors are much more active traders, and thus it is active investors who are dominating stock trading, which drives prices.

"Far from undermining the markets, indexing has unleashed new competition, driven innovation and identified new ways to deliver profits," Novick writes.

Even if indexing's continued rise were ever to reach the point of distorting prices, Novick predicts that that would just give active managers more chances to shine by outmaneuvering those distortions.

Indeed, a case-in-point is Hennessy Advisors, a publicly traded (HNNA on the Nasdaq) asset manager that manages nearly $7 billion across 14 mutual funds. HNNA was included in the Russell 2000 index until earlier this year. On June 12, Russell revealed that, effective June 23, HNNA and a number of other stocks would be removed from the index, while other stocks would be added.

As Hennessy Advisors chief Neil Hennessy pointed out yesterday, Russell's decision meant that any index funds tracking the Russell 2000 would have to sell HNNA. Indeed, on June 23 the trading volume for HNNA reached 457,200 shares, more than 50 times its average daily volume of 9,069 shares. Yet while the indexers sold, some active investors bought, and now HNNA trades for $16.50 a share, up more than eight percent since June 9, the market day before Russell announced the index changes.

Hennessy shared the Russell story at his packed, tenth annual press lunch at Mastro's steakhouse in New York City, where he presented his 2018 market outlook and PM Brian Peery walked reporters through the annual changes to the quantitative Hennessy Cornerstone Mid Cap 30 Fund's portfolio. 

Edited by: Neil Anderson, Managing Editor


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