The Curmudgeon

October 01, 2003

It's lunchtime as I write this, which makes me think of he ubiquity of America 's favorite food purveyor - McDonald's. Big Macs are the currency of my son 's world and, strangely, that of pundits in London, too. The Economist, that bastion of financial rectitude, cooked up a Big Mac Index some years back as a relatively simple way to calculate the over-and under valuation of currencies against the U.S. dollar.

According to the "burgernomics" notion, purchasing power parity is that exchange rate that leaves burgers costing the same in say, Burundi, as in America, since the locally produced concoction follows, more or less, the same recipe as its U.S. cousin.

In a global marketplace where glopburgers are commoditized, how much more information would be made available to consumers, economists or London journalists if, say, Burger King's "Whopper "was used in place of Mickey D's Big Mac?

My retort: "Not much, if any at all." (Forgive me. I talk to myself.)

And so it goes with indexes of the stock sort. Once a representative benchmark of the large-cap class, for example, is birthed, how much better off are investors with more choices? And how many more indexes can he marketplace reasonably support?

Put into he context of exchange-traded funds, how much market share is left for johnny-come-latelys after ETFs based upon the S&P 500 and the Russell 1000 have been launched?

Excuse me, but here's where I talk o myself again: "Not much."

Two closely related, yet significantly different, benchmarks per asset class seem to make sense. Why? For tax loss harvesting, that's why. At year-end, if one holds a losing fund tied tightly to the S&P 500,one can sell it, roll the proceeds into a fund bench-marked to a similarly targeted fund, wait to pass through the wash sale safe harbor, then plow the money back into the S&P 500 fund, thereby claiming a loss deduction.

The menu, however, from which investors must choose large-cap replacement therapy, is cluttered with funds. There are two funds mimicking the S&P 500,one based upon the S&P 100, a fund that tracks the Russell 1000,one following the Fortune 500 Index, another matched to he Dow Jones Industrial Average and yet one more tied to the Nasdaq 100.

Tangling 'round the feet of investors is this question: "Which benchmarked fund is close enough to the class that I 'm selling out of to keep my asset allocation intact, yet different enough to avoid an 'at-risk ' challenge from the IRS?"

More fundamental, however, is the question that the fund purveyors should ask:

"What are the prospects of stealing market share from the established large-cap funds in the first place?"

Again, I talk to myself: "Not good."

Such pessimism arises because stable markets typically have no more than three significant competitors. A two-to-one ratio between competitors seems to be an equilibrium point at which neither benefits from changes in relative share.

On top of that, the market share enjoyed by the largest rival is hardly ever more than four times that of the smallest. A ratio of four-to-one is the most the smallest competitor can usually tolerate. If relative market share falls to less than a quarter, a competitor's business, at best, is doomed to be marginal.

These rules, posited some time ago by the geniuses at Boston Consulting Group, when taken together imply that a stable market will move to equilibrium with each competitor owning one-half the market share of its next-biggest rival -in short, a four-to-two-to-one paradigm.

That said, a position other than leadership or second place is not viable over the long term in a truly competitive market. So, as I wolf down McDonald 's best, I offer this advice to fund companies looking to establish new beach heads in ETF-land: "Forget it. It 's already been done."

Now, do you want fries with hat?


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