Can a Brokerage Firm Screw Up an Index Fund?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
GoneOnTilt
Posts: 1841
Joined: Fri Sep 28, 2018 4:59 pm

Can a Brokerage Firm Screw Up an Index Fund?

Post by GoneOnTilt »

Simple question: Is there a risk of a major brokerage firm like Fidelity or Vanguard screwing up a total bond or stock market index fund? These funds do have managers. Is there any manager risk whatsoever? Or are the funds entirely automated?

Actionable question: does it make sense to diversify among firms even with index funds?
User avatar
sunnywindy
Posts: 655
Joined: Sat Jan 18, 2014 3:42 pm
Location: Central California

Re: Can a Brokerage Firm Screw Up an Index Fund?

Post by sunnywindy »

Is there a risk of a major brokerage firm like Fidelity or Vanguard screwing up a total bond or stock market index fund? No
Is there any manager risk whatsoever? No
Or are the funds entirely automated? No
does it make sense to diversify among firms even with index funds? No
Powered by chocolate!
retiringwhen
Posts: 4743
Joined: Sat Jul 08, 2017 10:09 am
Location: New Jersey, USA

Re: Can a Brokerage Firm Screw Up an Index Fund?

Post by retiringwhen »

Is diversification necessary or even valuable on the margins to reduce risk? probably not, the idiosyncratic manager risk is pretty small approaching zero.

OTOH, due diligence on your choice of Fund Manager and choice of Index is worth the time for a long-term buy and hold decision. Some indexes track the market better than others or track the specific portion of the market you are interested in matching.

Additionally, execution does vary from fund manager to fund manager. Expense Ratios, use of securities lending to reduce tracking error and just overall transaction efficiency can may a difference from both tracking error and tax efficiency.

With that in mind, just about any S&P500 index fund/ETF from one of the big Fund houses (BlackRock, Vanguard, Fidelity, Schwab, etc.) will show little or no difference before differences in expense ratio. There are some real stinkers out there with S&P Index funds with expense ratios over 0.5%!

Total Stock Market Index funds will vary somewhat, mostly driven by their index construction as well as manager execution, mostly in the small cap space.

Tax Efficiency can be varied as well, with ETFs generally being more tax efficient (but Vanguard's Mutual Funds are equivalent due to their share structure), but manager execution can make a difference there too.

If you are interested in the intricacies of Index fund management, I strongly suggest you listen to the Latest Bogleheads on Investing Podcast where Rick Ferri interviews the managers of the Vanguard Total Stock Market Index Fund. Here's a hint, human judgement and execution is critical to successful management of an index fund. It is not yet algorithmic (and probably never will be significantly automated).
psteinx
Posts: 5801
Joined: Tue Mar 13, 2007 2:24 pm

Re: Can a Brokerage Firm Screw Up an Index Fund?

Post by psteinx »

GoneOnTilt wrote: Thu Sep 16, 2021 9:44 am Simple question: Is there a risk of a major brokerage firm like Fidelity or Vanguard screwing up a total bond or stock market index fund? These funds do have managers. Is there any manager risk whatsoever? Or are the funds entirely automated?

Actionable question: does it make sense to diversify among firms even with index funds?
1) You're somewhat confusing "Brokerage firm" with "Fund management firm". Some companies do mainly one, some do mainly another, some do both. It so happens that both Fido and Vanguard have big operations on both sides, but the fund management side runs the funds. The brokerage side handles transactions for regular retail clients and others.

2) Yes, funds have managers. Basically nothing is fully automated, as far as I know. Yes, it should be theoretically easier to operate an index fund than a comparable actively managed fund. But human decision making is involved.

3) I think manager risk ("oh, I pressed the wrong button and liquidated all of our stock") is likely low for the big index funds run by the big managers like Fido & Vanguard.

4) There may be *brokerage* firm risk. There should be a form of insurance on clients' funds (SIPC, I think), that should cover most retail investors. But some folks (including me) do see a bit of wisdom in spreading assets across 2+ brokers.

5) Probably more of the risks lie with actions by the clients - you and me. There are a variety of things that *we* can do wrong to mess up our accounts and/or returns. One (of many) paths to problems is if the client is too old and loses a significant degree of cognitive functioning, perhaps without fully realizing it. That, in turn, opens the door to other problems.
fallingeggs
Posts: 158
Joined: Sat May 04, 2019 7:11 am

Re: Can a Brokerage Firm Screw Up an Index Fund?

Post by fallingeggs »

Index funds don’t perfectly track the index, but they are pretty dang close. I wouldn’t call this a screw up.

If you are asking about having a major loss while the index is just fine, then I’d say there is a very remote chance of that happening. There are too many safe guards and checks in place for something to be screwed up and go unnoticed/corrected for more than a few days, so your chance of a big disconnect from the index is tiny.

But not so impossible that I prefer to (slightly) diversify across providers/funds. Having literally a 3 (or even 2!) fund portfolio would concern me.
alex_686
Posts: 13320
Joined: Mon Feb 09, 2015 1:39 pm

Re: Can a Brokerage Firm Screw Up an Index Fund?

Post by alex_686 »

Define "screw up".

It is not automated. Or at least in the sense that you think. Most fund are well. Most of the big assets managers run things at a very high standard. Normally you have to dig into performance differences of bps (0.01%) to figure out which is best.

Very low risk from index methodology, to fund management, to broker.

I think there is more risk in increased complexity by diversifying like you suggest.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
User avatar
nisiprius
Advisory Board
Posts: 52212
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Can a Brokerage Firm Screw Up an Index Fund?

Post by nisiprius »

There are degrees and degrees.

At two different times, Fidelity and Vanguard "screwed up" their bond index funds, with the odd result that they more or less tied. They each had a single year in which they noticeably underperformed the index.

The extent of the screwup wasn't serious.

For Fidelity, the problem occurred in 2007-2008:
Source

Image

For Vanguard, I'm having trouble finding a suitable chart, because Morningstar will only plot the Bloomberg Barclay's float-adjusted aggregate index, which began in 2009, whereas Vanguard's fund had its problem year in 2002.

The bottom line, though, is that from 9/16/2001 through 9/16/2021, $10,000 would have grown to:
$22,837 in Vanguard's VBMFX (4.22% average annual return)
$23,270 in Fidelity's FXNAX (4.31% average annual return)
$23,681 in the Bloomberg Barclay's aggregate index, if you could invest in it at zero cost (4.40% average annual return)

The actual annual returns were:

Image

As another example, in a somewhat exotic asset class, in 2010 Rick Ferri complained that in 2009, the truth about micro cap index funds is that
They don't exist. They can't exist because most micro-cap stocks are not investable.
He pointed out that
The Wilshire US Micro-Cap index was up 47.6%, and the CRSP Decile 10 Index, which measures the smallest micro-cap stocks, registered a whopping 81.7% gain
but that none of the four micro cap index funds and ETFs he looked at returned more than 26%. That's probably not a screw-up, but certainly a case of index funds not fulfilling what might have been expected of them.
Last edited by nisiprius on Thu Sep 16, 2021 1:27 pm, edited 2 times in total.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
User avatar
nisiprius
Advisory Board
Posts: 52212
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Can a Brokerage Firm Screw Up an Index Fund?

Post by nisiprius »

With regard to what index fund managers actually do, a wonderful recent episode, #37 of the Bogleheads on Investing Podcast, includes an interview with the managers of the Vanguard Total Stock Market Index Fund and it is fascinating. Every day there are corporate actions like mergers and acquisitions, and when there are almost 4,000 stocks in the fund that means there are several dozen stocks where the manager has to review what happened and take some action.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
senex
Posts: 1087
Joined: Wed Dec 13, 2017 3:38 pm

Re: Can a Brokerage Firm Screw Up an Index Fund?

Post by senex »

nisiprius is such a treasure. Amazing memory.

I agree with him that anyone can (in theory) screw up anything, and that corporate actions can be notoriously difficult to get right.

I hold several similar etfs, that I mentally treat as "one fund," but not for the reason the OP suggested (clerical errors). The main reason is the accidents of how I acquired them (mostly, pre-boglehead). But also, once you have nontrivial money in a taxable account (where there is a tax cost to changing etfs), it is not crazy to diversify against unpredictable risks.

An etf can raise its expense ratio, change its investment objective, change its benchmark index, have an accounting scandal, become thinly traded (i.e. high spread/cost to liquidate), or many other things. These are rare, but not unheard of. I'm not sure I recommend "spreading it around," but it's not totally crazy. It adds a little complexity (say, owning 6-9 etfs instead of 3), but that's manageable.
ChinchillaWhiplash
Posts: 1574
Joined: Sat Jan 20, 2018 4:40 pm
Location: Land of Hypoxia

Re: Can a Brokerage Firm Screw Up an Index Fund?

Post by ChinchillaWhiplash »

Not all funds are created equal, even when following the same index. But they will all track very close to each other and the differences will be irrelevant after holding them for a few years. They do what they think will best mimic the index. Best to go with the lowest cost in most cases. No need to diversify between like funds.
User avatar
patrick013
Posts: 3301
Joined: Mon Jul 13, 2015 7:49 pm

Re: Can a Brokerage Firm Screw Up an Index Fund?

Post by patrick013 »

GoneOnTilt wrote: Thu Sep 16, 2021 9:44 am Actionable question: does it make sense to diversify among firms even with index funds?
Probably not. But what about the indexes ? Will LC indexes be the same ?
This market is not a good sample but here are some differences in their
top investments. I like quality when the market is in deep trouble. This
market has some great profit companies but also a slew of deadbeats in
many indexes. Recent 5 year returns have FTSE quality/div index doing well
(with no ETF available) with all 3 showing a variety of quality companies to feel safe in.


QUALITY DIV INDEX S&P
8.75% 5 year return

QUEST DIAGNOSTICS INC
GARMIN LTD
CABOT OIL & GAS CORP
ROBERT HALF INTL INC
PFIZER INC
INTERPUBLIC GRP
T ROWE PRICE GROUP INC
EATON CORP PLC
WELLTOWER INC
PUBLIC STORAGE

.......................

QUALITY DIV INDEX FTSE
12.9% 5 year return

Cisco Systems
Johnson & Johnson
Intel Corp
Texas Instruments
Procter & Gamble
Verizon Communications
Pfizer
AT&T
Exxon Mobil Corporation
Home Depot

.............................

QUALITY DIV INDEX MORNINGSTAR
7.14% 5 year return

EXXON MOBIL CORP
JOHNSON & JOHNSON
VERIZON COMMUNICATIONS
CHEVRON CORP
PROCTER & GAMBLE
PHILIP MORRIS
CISCO SYSTEMS INC
COCA-COLA
MERCK & CO
BROADCOM INC
age in bonds, buy-and-hold, 10 year business cycle
shess
Posts: 2164
Joined: Wed May 17, 2017 12:02 am

Re: Can a Brokerage Firm Screw Up an Index Fund?

Post by shess »

GoneOnTilt wrote: Thu Sep 16, 2021 9:44 am Simple question: Is there a risk of a major brokerage firm like Fidelity or Vanguard screwing up a total bond or stock market index fund? These funds do have managers. Is there any manager risk whatsoever? Or are the funds entirely automated?

Actionable question: does it make sense to diversify among firms even with index funds?
I agree with someone else's comment to listen the the Bogleheads podcast episode. One of the things which helped convinced me to finally convert to a straight three-fund portfolio was reading "Active Index Investing: Maximizing Portfolio Performance and Minimizing Risk Through Global Index Strategies". It's a collection of bits and pieces from various investment professionals, and thus is a bit uneven. And, of course, it's pretty dry :-). But the end result for me was to realize that:

A) indexing well is NOT that easy.
B) the kind of hard that indexing is is the kind of hard you CAN address using smart and experienced people.

A natural consequence of A is that indexing is about building and training a team to implement things, and a consequence of B is that those are exactly the kinds of people who are going to notice things going awry and rein it in.

Or, put it another way, I feel like a place like Vanguard can build an indexing team which looks surprisingly like the teams I've seen at software startups. The work they are doing rewards hiring top-notch people rather than hiring second-tier people, and the scaling factors mean that they don't have to hire so many people as to dilute the averages. This likely also applies to the various other top-tier indexers.
Topic Author
GoneOnTilt
Posts: 1841
Joined: Fri Sep 28, 2018 4:59 pm

Re: Can a Brokerage Firm Screw Up an Index Fund?

Post by GoneOnTilt »

nisiprius wrote: Thu Sep 16, 2021 1:25 pm With regard to what index fund managers actually do, a wonderful recent episode, #37 of the Bogleheads on Investing Podcast, includes an interview with the managers of the Vanguard Total Stock Market Index Fund and it is fascinating. Every day there are corporate actions like mergers and acquisitions, and when there are almost 4,000 stocks in the fund that means there are several dozen stocks where the manager has to review what happened and take some action.
Nisiprius, thank you for both your posts. And I will be sure to listen to the podcast.

The message I get from the information in your first post is that errors are fairly uncommon, and that over time the major managers have pretty closely tracked the respective indexes with their funds. It is probably not a worry. I currently use index funds at both Fidelity and Vanguard.

Thanks again and thanks to everyone for their interesting and helpful responses.
User avatar
bertilak
Posts: 10725
Joined: Tue Aug 02, 2011 5:23 pm
Location: East of the Pecos, West of the Mississippi

Re: Can a Brokerage Firm Screw Up an Index Fund?

Post by bertilak »

senex wrote: Thu Sep 16, 2021 2:23 pm An etf can raise its expense ratio, change its investment objective, change its benchmark index, have an accounting scandal, become thinly traded (i.e. high spread/cost to liquidate), or many other things.
Yes, but it is not a brokerage that does this. (Note the title of this thread.) It is the ETF itself. Same with traditional index funds.

Of course a brokerage CAN screw up your account. One brokerage I used to deal with bought the wrong fund. The tickers were very similar (two letters transposed, I think). The brokerage couldn't accuse me of making the mistake because it was the brokerage that recommended the buy and I just said "OK." They corrected the error.
Last edited by bertilak on Fri Sep 17, 2021 8:56 am, edited 1 time in total.
May neither drought nor rain nor blizzard disturb the joy juice in your gizzard. -- Squire Omar Barker (aka S.O.B.), the Cowboy Poet
Topic Author
GoneOnTilt
Posts: 1841
Joined: Fri Sep 28, 2018 4:59 pm

Re: Can a Brokerage Firm Screw Up an Index Fund?

Post by GoneOnTilt »

retiringwhen wrote: Thu Sep 16, 2021 10:55 am If you are interested in the intricacies of Index fund management, I strongly suggest you listen to the Latest Bogleheads on Investing Podcast where Rick Ferri interviews the managers of the Vanguard Total Stock Market Index Fund. Here's a hint, human judgement and execution is critical to successful management of an index fund. It is not yet algorithmic (and probably never will be significantly automated).
This is really an amazing podcast. I hadn't gotten to it yet. So many moving parts and yes, human judgment is involved. At least it's good to know that lots of people sign off at the end of the day. I work in risk management in health care and believe it or not I recognized some similarities in terms of process.

Thanks to you and nisiprius for sharing this and to Rick Ferri for a great episode.
Oregano
Posts: 365
Joined: Fri Nov 22, 2019 8:30 pm

Re: Can a Brokerage Firm Screw Up an Index Fund?

Post by Oregano »

Should you expect your index fund to screw up? No, but it has happened before.

Vanguard Total Bond Market underperformed benchmark by a few hundred basis points during 2000-2002 period due to over-concentration on some credit bets that went wrong.

Schwab had a number of active bond fund disasters in 2007-8 due to heavy concentration in illiquid structured debt. Their bond index fund had a taste of the same holdings and also took a hit, underperforming by a very large margin and was eventually liquidated.

Invesco screwed up just over a year ago, but made investors whole.
https://citywireusa.com/professional-bu ... r/a1354325

Vanguard as 529 administrator screwed up within the past year, but it worked in most investors favor
https://www.pionline.com/investing/vang ... a-529-plan
User avatar
Brianmcg321
Posts: 1875
Joined: Mon Jul 15, 2019 8:23 am

Re: Can a Brokerage Firm Screw Up an Index Fund?

Post by Brianmcg321 »

Lol. Threads like this are hilarious.
Rules to investing: | 1. Don't lose money. | 2. Don't forget rule number 1.
Topic Author
GoneOnTilt
Posts: 1841
Joined: Fri Sep 28, 2018 4:59 pm

Re: Can a Brokerage Firm Screw Up an Index Fund?

Post by GoneOnTilt »

deleted
Last edited by GoneOnTilt on Fri Sep 17, 2021 7:52 pm, edited 1 time in total.
Retired Bill
Posts: 105
Joined: Sun Sep 12, 2021 5:18 pm

Re: Can a Brokerage Firm Screw Up an Index Fund?

Post by Retired Bill »

nisiprius wrote: Thu Sep 16, 2021 1:25 pm With regard to what index fund managers actually do, a wonderful recent episode, #37 of the Bogleheads on Investing Podcast, includes an interview with the managers of the Vanguard Total Stock Market Index Fund and it is fascinating. Every day there are corporate actions like mergers and acquisitions, and when there are almost 4,000 stocks in the fund that means there are several dozen stocks where the manager has to review what happened and take some action.
This is a must listen to interview. So much material covered, had to listen to it twice and take notes. Will listen to it a 3rd time. In Vanguard's checks and balances to make sure everything was done each trading day is for 3 parties to sign off at end of each day. Running an index has a lot of moving parts to get the fund as close as possible to matching the index and this interview covers many I never gave much thought to. That said, we don't know the future, but I'm comfortable with the risk with a single fund. Identify theft and my account being hacked is a risk I do wonder about and about I can do is try best to follow best practices. Another risk is what would happen if another WW III commenced and escalated to nuclear weapons taking out internet/electricity for a period of time. My investment accounts would then be the least of my concerns!
Post Reply