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Index Funds Arent Speculators

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by Felix Salmon
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New Yorkers 1, Wall Street 0   Debating the Lehman Collapse

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Sep 12 2008 9:09am EDT

Index Funds Aren't Speculators

One of the first rules of headline writing is that you shouldn't go with anything which just sounds stupid. Like, say, this:

Speculative Bets by Index Funds Didn't Push Oil Prices Up, Report Says

Of course, the whole point of index funds is that they don't make speculative bets.

What the NYT is trying to talk about (and frankly the main story doesn't do a much better job than the headline) is the idea that commodity speculators were using index funds to bet on commodity prices rising, and that all that money flowing into those index funds was partly responsible for the increase in the price of oil. It turns out, not so much. Here's the WSJ, explaining quite clearly:

A widely anticipated study by the Commodity Futures Trading Commission also cast doubt on whether a big force blamed for pushing up oil prices this year -- investment in baskets of commodity futures, or index-linked funds -- was responsible, citing fresh data that index investors actually reduced their total bets on oil this year.

Index funds are useful and harmless creatures. They're not perfect -- no financial instrument is: they ratify high prices, for instance, because they assiduously take no position at all on whether any security might be too expensive or too cheap. But it's not a good idea to even hint that they might be speculating in anything: that one headline could, at the margin, keep a retail investor in high-priced mutual funds. Which do speculate.

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