Can You Really Game Index Funds?

https://news.ycombinator.com/item?id=9844686

Just because Vanguard claims to be smart about it, doesn't mean necessarily they actually are incentivized to be smart about it or actually are in practice. People can still judge them by how close they track the index, but that is reported separately from fees, which are all a lot of current and future retirees look at after having fees fees fees drilled into their heads. And the indexes themselves take a hit, so you need to adjust for that with a much more complicated measure.

They can effectively launder bad (or even good) tracking of the index into lower reported fees, by letting the order handlers profit on the inanity (and kickback via order-flow payments), allowing the fund managers to give themselves higher compensation without commiserate alarming fees.

To what extent, if any, do they actually do this? Do they report their income from paid order-flow in the fund prospectuses? Do they break it out by the managed funds, vs retail flow from their clients? Do they get major concessions to their retail trading costs in tacit exchange for being dumb with their etfs?

It is basically order flow that often blindly takes liquidity. Traders pay to get it, execute it prop at the best price (though they also can dump straight to the market without taking it prop if it isn't behaving dumb enough). Then they resell the position on the market at a more deliberate pace, providing liquidity (which lets them capture the spread, and lets them earn kickbacks from exchanges that pay for liquidity). Or they match the positions against future dumb flow coming in on the other side.

Also by this logic total market funds should outperform other indexes by a healthy amount over time. Also maybe not what we are seeing. Granted total market funds invest in something that is different from what other indexes track.