Vanguard: The Problem of World Domination?

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backpacker
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Vanguard: The Problem of World Domination?

Post by backpacker »

There are many versions of the "what if index funds get too big" question. Here's mine.

Vanguard index funds could, theoretically, control more than 50% of the outstanding shares of most publicly traded companies. Suppose that happens. Then no hostile takeovers of any company could happen without Vanguard's approval. On the flip side, any hostile takeover would happen as long as Vanguard funds wanted it to happen. A few Vanguard index funds would essentially run the economy. That looks like a problem.

Of course for now, this problem is only hypothetical. But it might not be in the future! :beer
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Re: Vanguard: The Problem of World Domination?

Post by Silence Dogood »

How close is this to happening?
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Re: Vanguard: The Problem of World Domination?

Post by backpacker »

Index funds, of which Vanguard's are by far the largest, together own 15%-20% of the total market. Even if Vanguard funds don't get over 50%, owning even 30%-40% of every publicly traded company would be a big deal in terms of shareholder voting.
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Re: Vanguard: The Problem of World Domination?

Post by nisiprius »

Silence Dogood wrote:How close is this to happening?
You're not allowed to ask that question in response to a "what if everybody indexed."

Nevertheless... the total capitalization of the U.S. stock market is on the rough order of $19 trillion, and Vanguard holds about $3 trillion in total assets. Of course some of that is overseas and some of that is bonds. It seems that the very most Vanguard could possibly hold would be 3/19 = 16% of the U.S. stock market, but it must be much less than that.

On the other hand, Total Stock holds $400 billion, Total Bond $200 billion, so it must be at least 0.6/19 = 3%.

I assume that the figures for Total Stock already include the holdings of Total Stock within the funds-of-funds.

I don't think I want to dig any further than "Vanguard holds between 3% and 16% of all U.S. listed stocks."

Another question that needs to be asked is this: the rules say that a "diversified" mutual fund can hold no more than 10% of the outstanding shares for any one security. So, if Vanguard's holdings got to be more than 10% of the U.S. stock market, they would have to start calling their mutual funds "non-diversified." I don't know what the consequences of that would be.

Of course, if present trends continue... but then again Mark Twain wrote:
In the space of one hundred and seventy-six years the Lower Mississippi has shortened itself two hundred and forty-two miles. That is an average of a trifle over one mile and a third per year. Therefore, any calm person, who is not blind or idiotic, can see that in the Old Oölitic Silurian Period, just a million years ago next November, the Lower Mississippi River was upwards of one million three hundred thousand miles long, and stuck out over the Gulf of Mexico like a fishing rod. And by the same token any person can see that seven hundred and forty-two years from now the Lower Mississippi will be only a mile and three quarters long, and Cairo and New Orleans will have joined their streets together, and be plodding comfortably along under a single mayor and a mutual board of aldermen. There is something fascinating about science. One gets such wholesale returns of conjecture out of such a trifling investment of fact.
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Re: Vanguard: The Problem of World Domination?

Post by lack_ey »

Silence Dogood wrote:How close is this to happening?
Very far away. Most of the top market cap US companies are something in the range of about 5% owned by Vanguard, 4% by State Street, 3% by BlackRock. You can check this in the "ownership" page for a stock on Morningstar.

Note that it varies from company to company because of various active funds, style tilted funds, etc. It's not like everyone just owns the market-cap weighted index. Also, because of index breakpoints, there are some anomalies in ownership like companies at the top of the Russell 2000 having a lot more passive investment than those with a slightly larger market cap that are at the bottom of the Russell 1000. Some companies near the top of the CRSP small cap indexes are more heavily represented by Vanguard.
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Re: Vanguard: The Problem of World Domination?

Post by neurosphere »

nisiprius wrote: Another question that needs to be asked is this: the rules say that a "diversified" mutual fund can hold no more than 10% of the outstanding shares for any one security. So, if Vanguard's holdings got to be more than 10% of the U.S. stock market, they would have to start calling their mutual funds "non-diversified." I don't know what the consequences of that would be.
I'm certainly no expert, but couldn't Vanguard just close an "almost non-diversified" mutual fund and open another one which tracks the identical index to get around maximum holding requirements?

Which brings me to a related question, what is the largest percentage of any one stock which is owned (in aggregate) by Vanguard? Obviously the index funds have to own some shares if the stock is in the index. But then imagine that there are several overlapping indexes. In addition, consider all of Vanguard's actively managed funds, which might drastically overweight any one stock. I wonder how close Vanguard might be to 10% across all of its mutual funds?
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Re: Vanguard: The Problem of World Domination?

Post by lack_ey »

neurosphere wrote:Which brings me to a related question, what is the largest percentage of any one stock which is owned (in aggregate) by Vanguard? Obviously the index funds have to own some shares if the stock is in the index. But then imagine that there are several overlapping indexes. In addition, consider all of Vanguard's actively managed funds, which might drastically overweight any one stock. I wonder how close Vanguard might be to 10% across all of its mutual funds?
I fished around a little bit and found a couple of stocks:
Duke Realty Corp. (equity REIT) is 13.85% owned by Vanguard, 7.54% through Vanguard's REIT index fund.
Centene Corp. (healthcare services) is 13.34% Vanguard. Blackrock owns 15.06% of it, though!
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Re: Vanguard: The Problem of World Domination?

Post by nedsaid »

backpacker wrote:There are many versions of the "what if index funds get too big" question. Here's mine.

Vanguard index funds could, theoretically, control more than 50% of the outstanding shares of most publicly traded companies. Suppose that happens. Then no hostile takeovers of any company could happen without Vanguard's approval. On the flip side, any hostile takeover would happen as long as Vanguard funds wanted it to happen. A few Vanguard index funds would essentially run the economy. That looks like a problem.

Of course for now, this problem is only hypothetical. But it might not be in the future! :beer
Blackrock and Fidelity might have something to say about that! They are both pretty big into indexing. If memory serves me correctly, Blackrock is larger than Vanguard.
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Re: Vanguard: The Problem of World Domination?

Post by asset_chaos »

As an index fund owner of everything, I don't think I care if one public company takes over another, hostile or friendly. Except for the deadweight loss of legal fees (and maybe investment banking fees) involved in the process, it's just a rearrangement of cash flows that all still end up in the pocket of the index fund owner. Even if the aquiring company doesn't pay a fair price (under or over paying), all the value still completely accrues to the index fund owner. The exception would be taking a public company private or partially private. Then the index fund owner could win or lose depending on if the price exchanged for the future cash flows of the company was fair or not. It may not even matter if the aquiring company improves the aquired buisness or runs it into the ground. That just means it increases or decreases market share, that it takes or loses buisness to rivals. But the index fund owns those buisnesses too, at least the public ones. The index fund owner seems at least partially shielded from the effects of this buisness management churn.
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Re: Vanguard: The Problem of World Domination?

Post by Maynard F. Speer »

I've said it before, but there's a limit to what percentage of dollars traded can be passive before markets become too inefficient to be effectively passively tracked ..

I'd estimate the limit to be around 22-25%, and I think you already pay a 'popularity premium' on cap-weighted indexes that may be engineering much of the apparent success of smart beta strategies

With machine intelligence likely taking over and producing all sorts of new financial products, I think there might be some speculative threat of the most effective 'player' eventually owning the whole market (an investing horizon of centuries would certainly be an advantage)
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Re: Vanguard: The Problem of World Domination?

Post by JoMoney »

The "world domination" may not be a "problem" for some investors. Some may even prefer less noise if it meant there was less need for such an active market. I know I don't need second by second (or even daily) price quotations. The liquidity is nice, and so are the low commisions/broker fees, but I can imagine a scenario where the buying and selling of publicly traded businesses looked more like the private business market, and Vanguard operated similar to a non-traded REIT.
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Re: Vanguard: The Problem of World Domination?

Post by nisiprius »

Maynard F. Speer wrote:I've said it before, but there's a limit to what percentage of dollars traded can be passive before markets become too inefficient to be effectively passively tracked ..
Logically, there must be a limit.
I'd estimate the limit to be around 22-25%, and I think you already pay a 'popularity premium' on cap-weighted indexes that may be engineering much of the apparent success of smart beta strategies...
How on earth did you make such an estimate? Personally, I'd have said it was about 95%, on the grounds that less than 5% of market participants are actually researching individual companies with the depth and insight needed to contribute anything to market efficiency.

What's the evidence for this "popularity premium?" There probably is a little in the S&P 500 but that's a red herring. Vanguard Total Stock Market Index Fund is twice the size of their S&P 500 fund, and IMHO it's the one Vanguard "promotes" and uses in their own all-in-one fund.

Please tell me how there can be a "popularity premium" on all 3,796 stocks in the Vanguard Total Stock Market Index Fund, which is designed to
designed to track the performance of the CRSP US Total Market Index, which represents approximately 100% of the investable U.S. stock market and includes large-, mid-, small-, and micro-cap stocks regularly traded on the New York Stock Exchange and Nasdaq.
"Approximately 100%." I'm looking for a more precise number on the CRSP website and not finding it... CRSP also says "representing nearly 100% of the U.S. investable equity market." Any "popularity premium" would be a rising tide that lifts 3,796 boats.
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Re: Vanguard: The Problem of World Domination?

Post by tadamsmar »

Vanguard CEO F. William McNabb III says managing so-called passive funds doesn’t mean a passive approach to corporate governance: ‘Nothing could be further from the truth.’
http://www.wsj.com/articles/vanguard-an ... 1425445200

Mutual funds and pensions own 42% of all US stocks and they are moving increasingly toward activism:

http://www.reuters.com/article/2013/04/ ... DU20130409
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Re: Vanguard: The Problem of World Domination?

Post by IlliniDave »

I think it's the buy and hold/low volatility aspect that will have more of an effect than indexing per se. Any buy and hold investor, index or not, removes a number of shares from the market, sometimes for decades. But if more people move away from picking towards holding, the pool of acting traders declines and the proportion of churned shares to churners should remain relatively constant. It would only be when the number of pickers/churners got very low that efficiency, such as it is, might wane.

Fortunately, there are enough compulsive competitors in the human species that we'll probably never see even half the investors out there investing passively/only in passive vehicles.
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Re: Vanguard: The Problem of World Domination?

Post by Maynard F. Speer »

nisiprius wrote:
Maynard F. Speer wrote:I've said it before, but there's a limit to what percentage of dollars traded can be passive before markets become too inefficient to be effectively passively tracked ..
Logically, there must be a limit.
I'd estimate the limit to be around 22-25%, and I think you already pay a 'popularity premium' on cap-weighted indexes that may be engineering much of the apparent success of smart beta strategies...
How on earth did you make such an estimate? Personally, I'd have said it was about 95%, on the grounds that less than 5% of market participants are actually researching individual companies with the depth and insight needed to contribute anything to market efficiency.

What's the evidence for this "popularity premium?" There probably is a little in the S&P 500 but that's a red herring. Vanguard Total Stock Market Index Fund is twice the size of their S&P 500 fund, and IMHO it's the one Vanguard "promotes" and uses in their own all-in-one fund.

Please tell me how there can be a "popularity premium" on all 3,796 stocks in the Vanguard Total Stock Market Index Fund, which is designed to
designed to track the performance of the CRSP US Total Market Index, which represents approximately 100% of the investable U.S. stock market and includes large-, mid-, small-, and micro-cap stocks regularly traded on the New York Stock Exchange and Nasdaq.
"Approximately 100%." I'm looking for a more precise number on the CRSP website and not finding it... CRSP also says "representing nearly 100% of the U.S. investable equity market." Any "popularity premium" would be a rising tide that lifts 3,796 boats.
I suspect 22-25% because that's what we're approaching today, and I think it explains two anomalies still present in markets that perhaps shouldn't be: 1) the momentum effect (which isn't as measurable in less efficient markets), and 2) the fact nonsensical smart-beta strategies (such as inverted strategies, or weighting by how many board members wear bow ties) seem to produce measurable alpha ..

Roger Ibbotson has a paper from 2014 - Dimensions of Popularity
http://www.zebracapm.com/research.php

At 95% passive (-traded dollars), I think two problems would be that price swings based on market knowledge would be dampened - so the active universe could sell out of Biotech, yet 95% of the market would still be holding it .. Presumably the sell-off would create a vacuum, and the passive allocation would go down, but I don't think it would go down proportionally ..

And investor market timing behaviour would become the predominant driver of asset pricing .. There's a 1% gap between time and dollar-weighted returns on indexes, and that's presumably driving the momentum effect ..

If you imagine the BitCoin market had 5% of traders academically quantifying value, and responding to market information, would they be able to make the market efficient? I don't think so .. I think the other 95% of the market would more likely render their attempts futile, and maintain it as a bubble market ..
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Re: Vanguard: The Problem of World Domination?

Post by JoMoney »

Maynard F. Speer wrote:...
I suspect 22-25% because that's what we're approaching today, and I think it explains two anomalies still present in markets that perhaps shouldn't be: 1) the momentum effect (which isn't as measurable in less efficient markets), and 2) the fact nonsensical smart-beta strategies (such as inverted strategies, or weighting by how many board members wear bow ties) seem to produce measurable alpha ..
Just a couple of points I wanted to comment on
- People have acknowledged "momentum" in the stock market, and implemented strategies around it long before index funds were ever available.
- The fact that "nonsensical" or strategies that don't have a good economic story associated with them may exhibit alpha, can be pretty easily explained by the fact that any deviation from the cap weighted market (that doesn't specifically focus on the very few number of stocks that are larger than the market's average market-cap) will have a small-cap like "tilt", and over the past 15 years or so smaller-cap stocks have outperformed large-caps.
There's a Vanguard Blog that makes a great parody about this:
http://vanguardadvisorsblog.com/2013/12 ... abet-etfs/

Vanguard's Total Stock Market currently has a median market-cap of about 48.9 billion. Out of 3781 stocks, there's less than 100 stocks that have a larger market-cap than 48.9 billion. Unless you're further emphasizing those stocks, you're going to wind up tilted to small.
We can debate whether or not investing in small-caps is likely to have a long-run greater return, but over the periods that they do have higher return, the effect is what it is... and it may result is all sorts of strategies that would seem to "beat the market" over that period
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Re: Vanguard: The Problem of World Domination?

Post by Maynard F. Speer »

JoMoney wrote:Just a couple of points I wanted to comment on
- People have acknowledged "momentum" in the stock market, and implemented strategies around it long before index funds were ever available.
- The fact that "nonsensical" or strategies that don't have a good economic story associated with them may exhibit alpha, can be pretty easily explained by the fact that any deviation from the cap weighted market (that doesn't specifically focus on the very few number of stocks that are larger than the market's average market-cap) will have a small-cap like "tilt", and over the past 15 years or so smaller-cap stocks have outperformed large-caps.
There's a Vanguard Blog that makes a great parody about this:
http://vanguardadvisorsblog.com/2013/12 ... abet-etfs/

Vanguard's Total Stock Market currently has a median market-cap of about 48.9 billion. Out of 3781 stocks, there's less than 100 stocks that have a larger market-cap than 48.9 billion. Unless you're further emphasizing those stocks, you're going to wind up tilted to small.
We can debate whether or not investing in small-caps is likely to have a long-run greater return, but over the periods that they do have higher return, the effect is what it is... and it may result is all sorts of strategies that would seem to "beat the market" over that period
1) When you look at the US markets between the 18th century and about 1950, you can identify momentum amongst a lot more chaos .. It's only really since about 1980 that the momentum effect's been so clear you can time the market with a mere SMA 300 and a monthly rebalance
http://upload.wikimedia.org/wikipedia/c ... 6P_500.png

If that had been the case in the 60s and 70s, technical analysis would've been an incredible brief topic ..

2) Brief studies on smart-beta strategies have generally assumed returns can be explained using the Three-Factor model .. Rob Arnott's study - which tests many real and hypothetical smart-beta strategies in much more detail, and upside down - finds returns can't be entirely explained using known factors
http://www.q-group.org/wp-content/uploa ... ll_Hsu.pdf

They suggest there be a hidden factor at work adding to returns (and perhaps adding some abstract risk) .. Ibbottson's paper from 2014 (linked earlier) suggests a negative factor: popularity .. Bear in mind, although index funds weren't available in Graham's era, many investors effectively indexed, and popularity could've been just as present then in other forms .. In both cases - momentum and popularity - I think you'd expect to find less today, as markets have become more efficient, and that doesn't seem to be the case

They might have nothing to do with index funds, but we know that there must be a theoretical limit in indexing popularity before it negatively impacts market efficiency - and I think this is how it would look: momentum and what you could call an anomalous contrarian factor
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Re: Vanguard: The Problem of World Domination?

Post by JoMoney »

Maynard F. Speer wrote:...
1) When you look at the US markets between the 18th century and about 1950, you can identify momentum amongst a lot more chaos .. It's only really since about 1980 that the momentum effect's been so clear you can time the market with a mere SMA 300 and a monthly rebalance..
A 300 day moving average actually performed pretty poorly for most of the the past 35 years. Most of its success is built on the 2008-9 crisis period.
The majority of the time it underperformed even a balanced stock/bond portfolio. The fact that it lined up well with the 2008-9 financial crisis is as far as I can tell a broken-clock effect. Strategy's using other time frames like 180 day MVA would have done poorly. Hindsight certainly makes it easier to pick what would have been the right market timing MVA, not so easy moving forward.
Also, your chart is a price only chart which neglects dividends. Dividend payout ratios have been reduced dramatically (especially since the 1980's). More of the price changes are built into capital appreciation. A "Total Return" chart doesn't show such pronounced differences in the markets return characteristics from one period to the next.
Image
Maynard F. Speer wrote:...
2) Brief studies on smart-beta strategies have generally assumed returns can be explained using the Three-Factor model .. Rob Arnott's study - which tests many real and hypothetical smart-beta strategies in much more detail, and upside down - finds returns can't be entirely explained using known factors ...
They suggest there be a hidden factor at work adding to returns (and perhaps adding some abstract risk) .. Ibbottson's paper from 2014 (linked earlier) suggests a negative factor: popularity .. Bear in mind, although index funds weren't available in Graham's era, many investors effectively indexed, and popularity could've been just as present then in other forms .. In both cases - momentum and popularity - I think you'd expect to find less today, as markets have become more efficient, and that doesn't seem to be the case

They might have nothing to do with index funds, but we know that there must be a theoretical limit in indexing popularity before it negatively impacts market efficiency - and I think this is how it would look: momentum and what you could call an anomalous contrarian factor
I agree. One of Graham's criteria for an "enterprising investors" strategy would be that it would have to be something not popular. Anything you find being made available as a mutual fund isn't going to fit the bill for this, especially not by the time someone finds people on chat boards talking about it.
But it doesn't change the effect that occurs over periods where small-caps out perform large-caps. There is a wider variety strategies that would have (or could have) beaten the cap-weighted market when viewed in hind sight over that period. It doesn't mean those same strategies will work going forward, or that small-caps will earn more going forward (I happen to believe they won't).
Most people shouldn't be trying to be an "enterprising investor". We can't all be above average, and empirically most of the funds and strategies people use to try to "beat the average" fail, often by an amount contributable to the additional costs incurred.
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Re: Vanguard: The Problem of World Domination?

Post by Maynard F. Speer »

JoMoney wrote:
Maynard F. Speer wrote:...
1) When you look at the US markets between the 18th century and about 1950, you can identify momentum amongst a lot more chaos .. It's only really since about 1980 that the momentum effect's been so clear you can time the market with a mere SMA 300 and a monthly rebalance..
A 300 day moving average actually performed pretty poorly for most of the the past 35 years. Most of its success is built on the 2008-9 crisis period.
The majority of the time it underperformed even a balanced stock/bond portfolio. The fact that it lined up well with the 2008-9 financial crisis is as far as I can tell a broken-clock effect. Strategy's using other time frames like 180 day MVA would have done poorly. Hindsight certainly makes it easier to pick what would have been the right market timing MVA, not so easy moving forward.
Also, your chart is a price only chart which neglects dividends. Dividend payout ratios have been reduced dramatically (especially since the 1980's). More of the price changes are built into capital appreciation. A "Total Return" chart doesn't show such pronounced differences in the markets return characteristics from one period to the next.
Image
Maynard F. Speer wrote:...
2) Brief studies on smart-beta strategies have generally assumed returns can be explained using the Three-Factor model .. Rob Arnott's study - which tests many real and hypothetical smart-beta strategies in much more detail, and upside down - finds returns can't be entirely explained using known factors ...
They suggest there be a hidden factor at work adding to returns (and perhaps adding some abstract risk) .. Ibbottson's paper from 2014 (linked earlier) suggests a negative factor: popularity .. Bear in mind, although index funds weren't available in Graham's era, many investors effectively indexed, and popularity could've been just as present then in other forms .. In both cases - momentum and popularity - I think you'd expect to find less today, as markets have become more efficient, and that doesn't seem to be the case

They might have nothing to do with index funds, but we know that there must be a theoretical limit in indexing popularity before it negatively impacts market efficiency - and I think this is how it would look: momentum and what you could call an anomalous contrarian factor
I agree. One of Graham's criteria for an "enterprising investors" strategy would be that it would have to be something not popular. Anything you find being made available as a mutual fund isn't going to fit the bill for this, especially not by the time someone finds people on chat boards talking about it.
But it doesn't change the effect that occurs over periods where small-caps out perform large-caps. There is a wider variety strategies that would have (or could have) beaten the cap-weighted market when viewed in hind sight over that period. It doesn't mean those same strategies will work going forward, or that small-caps will earn more going forward (I happen to believe they won't).
Most people shouldn't be trying to be an "enterprising investor". We can't all be above average, and empirically most of the funds and strategies people use to try to "beat the average" fail, often by an amount contributable to the additional costs incurred.

1) Well total return isn't as much use for looking at price momentum .. Beyond a point, compound interest becomes the main return, while the average holding period for a stock is 100-200 days .. And on the aside, trend-following strategies aren't necessarily about producing a higher return - they may be about producing a better risk-adjusted or absolute return ..

2) The small and large cap effect you mention is a factor in the Three-Factor Model .. In Arnott's study (linked) the smart-beta strategies are mathematically adjusted for these factors - that's what the study's looking at ... When Graham talks about popularity, it may be a difficult concept to separate from value .. Today it's a speculative concept that may differ from value (but is likely present at varying degrees within any market)

One of the oldest concepts in investing is that you shouldn't be where the herd is .. In any walk of life, the average get a raw deal - we've got concepts like the 80:20 rule .. 20% of photographers do quite well; 80% spend a lot on lenses and never take a decent picture .. That's not a reason not to do things .. If you're well suited to something, you should put energy into doing it well - why not do it as well as Swensen or Buffett? .. If not, you should leave it alone and not waste any energy thinking about it .. And with investing, the later is made easy for you now
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Re: Vanguard: The Problem of World Domination?

Post by Leeraar »

nisiprius wrote:Nevertheless... the total capitalization of the U.S. stock market is on the rough order of $19 trillion, and Vanguard holds about $3 trillion in total assets.
How is this counted?

Life Strategy owns Total Stock Market which owns AAPL. If we add up the capitalization of Life Strategy and Total Stck Market and AAPL, arem't the APPL shares effectively held by Life Strategy being counted three times?

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Re: Vanguard: The Problem of World Domination?

Post by garlandwhizzer »

There are realistic concerns regarding financial markets. Vanguard world domination is is not one of them, never has been and very likely never will be.

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Re: Vanguard: The Problem of World Domination?

Post by HardKnocker »

Warren Buffet will take over the world long before Vanguard does.

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