Barron’s reports on Pershing Square Capital manager Bill Ackman’s latest letter to shareholders, in which he sharply criticizes index funds. Ackman suggests that index funds are making the U.S like Japan, where the “system of cross-corporate ownership, the keiretsu, has been blamed for decades of Japanese corporate underperformance and market malaise.” He writes that “at current rates of inflows, it will not be long before index funds effectively control Corporate America and the corporations of many foreign countries,” which would create outcomes similar to Japan “without the counterbalancing force of large active investors and improvements in the governance oversight implemented by passive index fund managers.” He also proffers the common argument that index fund stocks are inherently overvalued: “as more and more capital flows into the index funds…the valuation of the indexed constituent companies increases.”

Others have commented on Ackman’s argument. Cullen Roche’s post on his Pragmatic Capitalist blog maintains that “even if index funds are influencing valuations, then this should create more opportunities for active managers” because “the purpose of more active strategies is to find slices of the market that won’t expose investors to systemic risk.” He also points to evidence that the market allocates capital better than active managers and attacks the high fees charges by hedge funds. Bloomberg View columnist Matt Levine also discusses Ackman’s argument and notes a symbiotic relationship between index funds and actively managed funds. “Index funds free-ride off concentrated fundamental investors’ valuation work, buying stocks at the market price with no view of their own on valuation; in exchange, though, they push valuations away from fundamentals and give the fundamental investors more opportunities to find value.”