NEW YORK, Oct 15 (Reuters Breakingviews) - For regular investors, the bad old days really were bad. Plenty of people can remember when buying into mutual funds involved paying a so-called load of 8% up front, a huge handicap for the punters in question. Such frictional costs were one impetus behind the idea of cheaply tracking market indexes rather than entrusting savings to expensive stock-pickers. The revolution was overdue. Academic research had showed that these particular masters of the universe were underperforming broader markets in the early part of the second half of the 20th century. Despite false starts, that insight eventually led to the creation of index-tracking mutual funds from the 1970s and, in the latest incarnation dating back to the 1990s, exchange-traded funds or ETFs. Finance will never look the same again. The story of how this came about provides the subject matter for “Trillions” by Financial Times journalist Robin Wigglesworth. It’s a thoroughly reported and engaging account, featuring characters including the indomitable John “Jack” Bogle, founder of the Vanguard fund powerhouse, Larry Fink, architect of the even-larger BlackRock (BLK.N), and Louis Bachelier, a French mathematician whose 1900 PhD thesis made an early contribution to the academic underpinnings of passive investing. The reshaping has come quickly. In U.S. financial markets, index-tracking funds made up 40% of the total $25 trillion invested in all funds at the end of 2020, up from under 20% of a much smaller total in 2010, according to the Investment Company Institute. Among trackers, American ETFs have now overtaken mutual funds. The United States is at the leading edge, but it’s a global phenomenon. Wigglesworth weaves the various stories together with flair, sketching the people and the corporate tensions and reconfigurations involved, such as BlackRock’s $13.5 billion acquisition of Barclays Global Investors in the midst of the 2008-2009 financial crisis. Taking control of the British bank’s iShares unit proved a foundational moment for Fink’s now all-powerful index-tracking business. In its latest earnings report the company, with a market capitalization of about $130 billion, reported $9.5 trillion of assets under management, of which $6.3 trillion is in index mutual funds and ETFs. This brought in $5 billion of quarterly revenue and $1.7 billion of profit, both records. The author intentionally avoids delving much into the technicalities of index funds and ETFs. That makes room for lots of anecdotes, but for a reader already acquainted with the outlines, the gap leaves a thirst. Still, the stories of who made index tracking happen, who failed, and how different people got along with each other or clashed, make for an enjoyable read. Wigglesworth concludes that funds that track benchmarks like the S&P 500 Index of big U.S. stocks have been an unequivocal boon to investors. That’s a fair assessment. There’s no doubt the products have made investing more accessible while also stripping out a big layer of expenses that were going into the pockets of fund managers and salespeople. Yet he doesn’t shy away from the questions thrown up by the industry upheaval. For example, passive funds don’t get to choose which stocks they invest in. If they can’t vote with their feet by selling a position, and if they are running so lean that they can’t afford to employ dedicated analysts, can they really hold a company’s management accountable? Stewardship initiatives, including for example BlackRock’s vocal positions on matters such as climate-related disclosures, go some way to addressing this, but it’s early days. There also remain questions about the stability of ETFs in a crisis, perhaps especially when a fund tracks less liquid instruments such as corporate bonds rather than stocks. Industry cheerleaders point to a bond-market crunch in February and March 2020 as evidence of the products’ robustness, while skeptics say the U.S. Federal Reserve came to the rescue too soon to justify that claim. Other concerns include the emergence of a new set of players with growing influence that has outrun the regulations enacted for an earlier market structure. Among them are proxy advisers, a field dominated by two companies, Glass Lewis and Institutional Shareholder Services. They basically tell fund managers who outsource such work how to vote on issues that come up for shareholder votes. Perhaps even more significant are the now multitudinous purveyors of indexes, some of the biggest being MSCI, FTSE Russell and S&P Dow Jones Indices. As Wigglesworth puts it, index funds “in practice delegate their investment decisions to the companies that create the benchmarks.” In short, index providers are the new active managers. Even when the parameters for index inclusion are objective, companies may change their behavior to get in, because being part of a benchmark forces all the investment vehicles that track it to buy the shares. But the criteria are not always black-and-white. Even selecting the constituents of the S&P 500 involves subjective decisions by the overseers of the index. The huge runup in electric-car maker Tesla’s (TSLA.O) value as it waited and then joined the benchmark is one example of the difference index inclusion can sometimes make. A working paper this month published by the National Bureau of Economic Research suggests companies that pay for credit ratings from S&P Global, which also owns the indexing business, “appear to improve their chance of entering the index.” Causation is hard to demonstrate conclusively. But where humans participate in decisions that can involve billions of dollars, other humans will try to influence them, and still, others will become suspicious of their motives and incentives. When the sums involved reach trillions of dollars, the industry’s integrity is at stake. There are few clear answers as yet. When index funds, and especially ETFs, have been around another decade or two, researchers and watchdogs alike will have gathered more data to work with. That’s when “Trillions” will need a sequel. Follow @richardbeales1 on Twitter CONTEXT NEWS - “Trillions: How a Band of Wall Street Renegades Invented the Index Fund and Changed Finance Forever” by Robin Wigglesworth was published by Portfolio on Oct. 12.