What Today’s Index ETFs Get Right, and Wrong, for Investors

When index funds first launched in the 1970s, they faced a chilly reception. Critics derided them as “unAmerican” and “settling for average.” When Vanguard launched the first index fund available to individual investors in 1976, it raised $11 million—a far cry from its $150 million target. Index funds’ slow start continued for years, and Vanguard’s S&P 500 fund became known as “Bogle’s folly.”

In hindsight, it’s easy to see where this went. Vanguard dominates the US fund industry in terms of assets, totaling over $8.5 trillion in US mutual funds and exchange-traded funds alone, including over $1.3 trillion tied to its S&P 500 “folly.” Vanguard isn’t the only firm riding the index fund wave: In 2023, index-tracking funds overtook their actively managed counterparts by net assets. Bogle’s vision proved prescient, and investors are fortunate that he stubbornly stayed the course amid early criticism.

The fact that the fund industry could be so wrong about index funds belies its selfishness. Those lobbing insults at Bogle and index funds weren’t thinking of what’s best for investors. They were either defending their book of business, not doing their homework on index funds, or both.

For a time, the industry kept index funds at bay. But they could survive the siege for only so long. Investors took notice of index funds’ success and the mounting research supporting them. Top researchers reeled off foundational papers demonstrating the lack of value created by active managers in aggregate, including Paul Samuelson, the first American to win the Nobel Prize in Economic Sciences, and would-be Nobel laureate Eugene Fama and his efficient market hypothesis.

Bogle wasn’t alone in his quest for index-fund adoption. Future titans of the fund industry circled their wagons around index funds. Wells Fargo WFC launched the first-ever index fund for institutional investors in 1971, led by a team including John McQuown, Rex Sinquefield, and David Booth. They later teamed up to found Dimensional Fund Advisors, which now manages $1 trillion in assets. Jeremy Grantham, co-founder of GMO, also established an index fund for Batterymarch Financial Management later that year. Aligning with investors and researchers helped propel these future titans of the fund industry to the top of their field.

The Positive Evolution of Indexes

ETFs have long intertwined with index investing. The first active ETF didn’t launch until 15 years after SPDR S&P 500 Trust ETF SPY made its debut in the US, and passive ETFs still account for 91% of US ETF assets. A considerable portion of active ETF assets sit in indexlike strategies, like those offered by the largest active ETF issuer, Dimensional. So, even active ETF assets share some of the original ETF DNA. It’s no surprise that the original architects of the index fund found ways to improve on the rigidity of indexes using active implementation.

Index funds also found ways to soften the edges of index tracking. Vanguard utilized multiday trading around index reconstitution to reduce the market impact of their orders and improve execution prices. Research Affiliates, the index designer and provider for Invesco RAFI US 1000 ETF PRF and Schwab Fundamental US Large Company ETF FNDX, went a step further in addressing rebalancing risk for their strategic-beta ETFs by splitting the index portfolio into four equal slices and rebalancing one each quarter. These improvements lower trading costs and smooth long-term performance by limiting the timing luck of rebalancing.

Advances in technology also opened doors for ETFs tracking indexes in niche markets. For example, early passive municipal-bond ETFs were forced to exclude illiquid corners of the muni-bond market due to limited technologies. For example, we previously assigned SPDR Nuveen Bloomberg Muni Bond ETF TFI a Below Average Process rating because of legacy exclusions from its 2007 inception, such as requiring bonds to be rated AAA and AA and excluding hospital, housing, tobacco, and airline-related muni bonds (it addressed these shortcomings by changing indexes in June 2025 and now receives an Above Average Process rating). These trade-offs made the index investable in 2007, but better muni-bond liquidity and improved electronic trading have rendered these exclusions unnecessary.

Fixed-income ETFs have benefited the most from technological advancements. Broader exposure allows index funds to better capture the opportunity set available to active managers and makes them harder to beat, thanks to their fee advantage.

High-yield bond ETFs are a great example of the small but meaningful differences between the original ETFs launched in 2007, iShares iBoxx $ High Yield Corporate Bond ETF HYG and SPDR Bloomberg High Yield Bond ETF JNK, and their contemporaries.

The table below compares the index restrictions of four index-tracking high-yield bond ETFs with analyst-assigned Morningstar Medalist Ratings. The early ETFs, iShares iBoxx $ High Yield Corporate Bond ETF and SPDR Bloomberg High Yield Bond ETF, tracked indexes with higher minimum face value requirements. Despite appearing to be minor differences, the indexes tracked by JPMorgan BetaBuilders USD High Yield Corporate Bond ETF BBHY and iShares Broad USD HY Corporate Bond ETF USHY capture nearly 70% more high-yield bonds than the original high-yield ETFs—a feature that, along with their lower fees, helped them outperform the incumbents.

JPMorgan BetaBuilders USD High Yield Corporate Bond ETF’s underperformance relative to iShares Broad USD HY Corporate Bond ETF highlights that there’s still an opportunity to improve the implementation of indexes. When starting a fixed-income ETF, it’s common to sample the index and then expand the portfolio when assets grow. Bonds typically trade in larger lots than stocks, such that it’s costly, if not impossible, to scale holdings with the ETF early on. Instead, managers are forced to patiently add new bonds as money rolls in. JPMorgan BetaBuilders USD High Yield Corporate Bond ETF spent much of its time holding significantly fewer bonds than its index, while iShares Broad USD HY Corporate Bond ETF quickly gathered assets and grew its portfolio rapidly. The different paths taken by these ETFs materialized as a 33-basis-point annualized advantage for iShares Broad USD HY Corporate Bond ETF.

Some Indexes Miss the Point

The virtues of indexing were built on foundational research, controlling costs, and low fees. It’s safe to say that not all the 2,000-plus index ETFs on the market today adhere to those same standards.

Incredibly, index ETFs track over 1,800 different indexes—a fact that made me do a double-take. More than 300 passive ETFs charged fees over 0.75%, making them more expensive than the average active ETF. These ETFs would be unrecognizable to the early index researchers whose shoulders they sit on.

In these cases, evolution is a commercial imperative rather than an improvement. Mainstream indexes have been commoditized; even some broad-market high-yield bond index ETFs charge less than 10 basis points. ETF issuers are forced to differentiate their strategies to find some white space for new assets for which they can justify higher fees.

Expensive, highly differentiated index ETFs are the antithesis of index investing. I don’t blame issuers for trying to run a business, but I also won’t be buying an index fund charging over 75 basis points.

ETF investors can avoid falling prey to profit-thirsty issuers by choosing index ETFs that charge low fees. Investors looking for something other than ultracheap broad market index ETFs can still find affordable options. Performance doesn’t really sour until the third fee quintile in the above chart. The breakpoint between the second and third fee quintiles was 0.35%, so aim for ETFs with fees below that watermark.

The ETF landscape is littered with past year’s must-have strategies. Be skeptical about new strategies that just so happen to charge high fees. Likewise, asset managers pitching more expensive funds have an incentive to persuade investors away from cheap index ETFs. The last person you want to take advice from is the one who coined the phrase “Bogle’s folly.”