The Origins of the Long-only Index Funds

Several months ago, a friend handed me Matt Taibbi’s best selling book, Griftopia, and said, “read it and tell me what you think.”  I don’t normally read muckraking books written in a contemporary style that is both “over the top” and crude.  However, after skimming a couple of chapters, I realized that Taibbi is a bright guy with some interesting things to say.  I was surprised when I turned the page and came to Chapter 4—“Blowout: The Commodities Bubble”—in which Taibbi discusses the long-only index funds (see particularly pages 132-141) that now dominate the futures markets.

Taibbi makes two main points about the origins of the long-only index funds.  First, Goldman Sachs and other big banks obtain at least 17 semi-secret letters from the CFTC—starting in the early 1990’s—that allowed them to ignore the existing limits on speculative positions and begin a profitable campaign of selling long-only commodity index funds to investors.  Second, the “Uniform Prudent Investor Act of 1994” was passed.  This Act, “some form of which would eventually be adopted by every state in the union,” ended the prohibition on investing in commodities by pension funds and trusts.  In fact, they are now “duty bound to diversify as much as possible” and that mean including commodity funds in their portfolios.  As I was reading Chapter 4, I received a call from the bank that manages the financial assets of a small trust I’m involved with.  The bank wanted to increase the Trust’s holdings of commodity funds—even though the Trust’s main asset is wheat land.  I had wondered why commodity index funds were starting to appear in the Trust’s portfolio.  After finishing the chapter, I understood.

For those interested in the origins of long-only index funds, Chapter 4 of Taibbi’s book is worth a look.