The point of the article is that owning an index fund is NOT buy-and-hold -- the indexs sell to rebalance, and do so in poorly timed ways (that is, in hige fixed batches, contrary to standard advise to "drip"), exposing investors to trading waste that the indexes are designed to avoid -- undermining the purpose of the index fund.
0.2% waste is huge compared to the overhead fee of an index fund. VTSMX fee is 0.17%.
I did mean higher than, but that is because I incorrectly included the overhead of front running in the expense ratio when I think it would actually manifest as a failure to track the index. Some total market funds end up being a hair pricier (VTSAX and VFIAX are both .05% right now).
Still, if you look at VFIAX it tracks the index perfectly despite front running so it is still nothing to worry about. The amount of money in index funds is large so there is room for a few people to make some money without a big impact. There is some deviation that is significant around the 35 year mark, but do we even know that front running is the cause?
My understanding is that in practical terms weighting shouldn't matter for indexes for the most part since you should only have to buy/sell when funds enter/leave the index (that is the bug). The weight should track without any active trading because it's based on market cap. You buy it and if the market cap increases so does the holding and if it decreases so does the holding. No need for trading.
Now if you want equal weighting among the 500. Well that is an issue. It's one reason not to buy an equal weighted fund.
I know people are thinking of other more problematic indexes than the S&P 500. I don't because I don't buy them so I haven't given a lot of thought to what front running means to them. My investment objective is to hold the entire investable space weighted by market cap (modulo currency risk and home bias) and most indexes play no part of that.
>>I think it would actually manifest as a failure to track the index
No, because the stock was added to the index on the same day. So the fund is tracking the index, and the index is doing what it said it would do. It's just that they're both buying in an inefficient way that costs more than it might, and others capitalize on that inefficiency.
Right, but that's the fund manager's problem, not mine. A savvy fund manager would run a front running fund as part of its portfolio.
Also note this is only a problem when the market is mid-term upward or flat. The chances of this type of front running backfiring are pretty high in a bear market. Also, like all forms of arbitrage, there is an upper bound on the number of shares you can do this with before you're dumping more shares on the market than the index funds need. Granted that's probably a big number, but it's not infinite.
0.2% waste is huge compared to the overhead fee of an index fund. VTSMX fee is 0.17%.
> higher than
You mean "lower than"