Is Passive Investment Actively Hurting the Economy?
newyorker.com
newyorker.com
Vanguard is definitely at the forefront of advocating "just put your money in an index fund and wait, don't try to time the market". There's a huge amount of money behind the alternative that will suffer if more people follow that advice. Media campaigns are, on that scale, relatively inexpensive.
In a recent Planet Money episode (#688: Brilliant vs. Boring), they talk about how when John Bogle first introduced the index mutual fund in 1975, it got a lot of criticism (and not much adoption) with people claiming that they were "un-american" and "Bogle's folly".
It's possible that there's some sort of concentrated media push going on here, but the story hasn't changed much in the last 40 years. And I would hope that if people with a lot of money were trying to smear index funds, they'd at least come up with a new angle.
My opinion is that if there exists campaign against such investment strategies, then it is possible that this has been going on quite long time already. Like the parent postulated: media campaigns are, on that scale, relatively inexpensive.
Investors with heavy ingluence/ownership of media have a lot of potential to earn from manipulating market volatility.
His opinion iirc is that at some point there will be an inflection point where there will once again be profits to be had through information discovery, and the two forces will balance out.
Hedge fund winning streaks are not a matter of chance, they are just extremely difficult to pull off.
In practice these two things appear similar; in theory they mean entirely different things about the market.
There clearly are strategies that make money at times. The majority off hedge funds do not offer these, and what they offer is hidden by their fees, which do not correspond to results, and even discourage good results as they encourage volatility.
Thus, it's not the hedge funds' strategies that need to be consistent, it's their R&D.
For that, I'd refer to http://longbets.org/362/ .
zero.
"Look more closely at those gaudy returns, however, and you may see something startling. The truth is that very few professional investors have actually managed to outperform the rising market consistently over those years. In fact, based on the updated findings and definitions of a particular study, it appears that no mutual fund managers have."
http://www.nytimes.com/2015/03/15/your-money/how-many-mutual...
ex: Since Horseman's inception in February 2001, the fund has achieved annualized returns of 14.79%, according to HSBC.
http://www.bloomberg.com/news/articles/2016-01-06/horseman-c...
http://www.zerohedge.com/sites/default/files/images/user5/im...
In this context the problem is that buying into an index fund does beat the market, because it simultaneously creates and then takes advantage of a bubble in the price of stocks in the index. The price of indexed stocks goes up because index funds are buying them. Then people buy into index funds because they're going up.
In theory non-index investors will then sell the indexed stocks once they're overpriced, but they can see the feedback loop. If more people are expected to invest in index funds in the future then the future demand for indexed shares will be even higher and the indexed shares will be worth even more tomorrow, so they become part of the bubble instead of correcting it.
market = index fund (S&P 500 based).
How can an index fund beat the market, if an index fund IS the market?
The SP500 is not the market or even a market, its a small sector selected by backwards view of the recent past top 500 large caps.
So buying an index fund that tracks SP500 means some churn as previously successful large companies are added, and recently unsuccessful large companies are removed.
A trivial example of SP500 beating the market (of all stocks) would be new regulations or whatever resulting in increased costs and harm to small cap stocks. Its not hard to imagine... a fixed cost of regulation that might shut down your local independent gas station might be a rounding error at BP. Imagine an accounting change that costs the same to implement no matter if you're talking about thousands or billions. Or PCI/DSS change. Anyway in that situation the small caps would drag down the market average but have no effect on the large caps in SP500, so the SP500 "would beat the market" easily.
What really is the market?
We could discuss it for hours, but the reality is that (US )"market" in finance does refer to the S&P500. So "beating the market" always means beating the S&P500.
http://www.bloombergview.com/articles/2016-03-11/passive-inv...
Maybe his views have solidified in favor of passive investing.
Either way though, balanced or skeptical, I trust Levine.
For one, he relies heavily on the expertise of a bank which is threatened by ETFs because it makes money in part by executing trading strategies to wealthy clients - very generally speaking, the more complex/active the trading, the more money the bank makes. Not that the Goldman guy is wrong, but the author should have acknowledged this conflict.
Also the idea that somehow the average person picking stocks can help make market efficient seems like a big stretch. It's really really hard to determine a fair price to pay for a stock. And anyway, there's an ENORMOUS amount of brainpower that already goes into outsmarting the rest of the market - probably more than ever - and it's that smart money that sets the price, for the most part.
The average person is supposed to pay someone to pick the stocks for them. I wonder who could promote this idea and rally against the alternatives...
It might be wrong. It was surely a little bit weird and surprising.
But it was definitely not ridiculous.
There's absolutely nothing wrong with setting up an organization owned by its shareholders and designed to not charge excessive fees. Resenting that and attacking Vanguard for it is an underhanded tactic by those who want to make money charging fees, and thus have trouble competing with Vanguard.
But yes, the tax charges weren't quite as "ridiculous" (in that they require more than a moment's thought to dismiss), though I still think they're completely baseless. (And also, "tax avoidance" is the perfectly legal and sensible practice of paying as little tax as possible; the allegations against Vanguard were of "tax evasion".)
While the details would need careful comparison to the various laws in question (which I would hope Vanguard has done), I would argue that Vanguard's structure is similar in principle to that of a cooperative. If you have an organization owned by its members, that organization serves only its members, and that organization charges lower prices because its structure makes it reasonable to operate at cost for the benefit of its members, then that organization will pay less tax because it takes in less revenue. And that's completely reasonable. It's not reasonable to argue that the organization should charge more to its members specifically so it can pay more tax. The same reasoning should apply to Vanguard, though how it may set up such a structure would require a great deal more care and complexity at larger scale.
The details of the complaint would require careful evaluation against the exact letter of the law; in particular, this isn't a comment on the separate allegation about the "contingency fund". The above is simply an argument that in principle, I don't see why this should apply to Vanguard when it doesn't apply to smaller-scale organizations operated for the sole benefit of their members.
Can you provide a link to the "dumping" argument, posed well, or by any credible market participant?
As far as I can tell, that case got dropped: http://articles.philly.com/2015-11-19/business/68386489_1_da... . Though it's still entirely possible that the IRS continues to pursue it separately (they haven't commented on the status of that), it no longer appears possible for the so-called "whistleblower" to pursue it directly or to collect.
> (On the other side of the argument: "rules are rules, and Vanguard has to comply with all of them, even the dumb ones.")
Granted; it's possible there's a "letter of the law" problem here, hence my comment that the tax argument isn't quite as ridiculous. However, in terms of actual justice being served, I don't think it's reasonable for an argument along these lines to apply to Vanguard but not to any random local co-op that serves its members. (I'm ignoring the second half of the complaint here about the "contingency fund", and focusing on the "not charging enough" argument, which seems far more obviously wrong in principle.)
The difference, as far as I can tell, is that co-ops have just the one legal entity owned by the individual members, whereas Vanguard involves a second corporate legal entity, due to the nature of how the funds own Vanguard; it's the same logical structure, but the legal entity topology differs, and that may make a difference. As far as I can tell, the laws trying to say "must charge market rates" (because charging less would mean paying less tax, and we can't have that...) refer to B2B transactions, not B2C transactions. I wonder why Vanguard structures its funds using two legal entities in this way, rather than a single legal entity directly owned by the funds it itself manages?
> Can you provide a link to the "dumping" argument, posed well, or by any credible market participant?
I can't seem to find a good isntance of it at the moment. I saw a few more recent instances of it in stories associated with the tax lawsuit, mentioned by random other fund representatives commenting on the suit. They struck me as the kind of comment made offhand, rather than a careful legal argument of any kind; however, I've seen that complaint in various contexts ever since I started following (and using) Vanguard myself, before I'd heard about the lawsuit.
The end of http://www.bloombergview.com/articles/2016-02-10/vanguard-is... makes a comparison between Vanguard's low fees and Costco members; that comparison isn't quite as accurate, since Costco charges its members a fee rather than being owned by its members, but it seems like the right line of reasoning at least.
http://www.forbes.com/sites/bruceupbin/2011/10/22/the-147-co...
It may be contributing to greater wealth inequality, though: if you look at basically anyone who has become fabulously wealthy in the last couple decades, it's because they saw a profit opportunity that others were unwilling or unable to exploit. The primary form of unwillingness is "It's too risky..."
Usually, once it's become apparent that some people are getting fabulously wealthy by breaking away from the herd, jealousy and Dunning-Krueger take over and you get a large number of people that are suddenly true believers in active investing.
1. You may not even be able to acquire shares or to dispose of them (everyone is passive!)
2. Low liquidity + required multiyear holding times = dramatically increased risk
3. Businesses are affected by the markets their shares trade in. Earnings can be depressed by increased costs of capital, sentiment and anti-competitive pressures from shareholders who hold the entire market.
The third is mildly concerning. If a few companies are swimming in money, they may disturb every market around. Historically this don't last for long, every time the market gets like this, there comes a crisis and destroys those big players. Worth keeping an eye to a "this time is different" event.
Now, the second one is the real problem here.
The first can't happen because you can't answer what is the correct price of a stock. :) That's a bit glib, but the only reason passive investors are said to not correct is because there are plenty of active investors to move the prices of stocks.
So if you're actually trading rather then just collecting dividends (and even then), then whether a stock moves is based less and less on the actual position of the business.
Holding them is fine, but index funds are the exact same thing: they're an exercise in cheaply diversifying to the broadest possible scale, which is the only way the little guy beats the algorithmic traders.
That's the Castle-in-the-Air theory of investing, and it's been popular for much longer than even digital computers, let along HFT (Keynes is said to invest based on it, and as described the logic in his Beauty Contest analogy). It's why many thousands of investors over a century have been poring over stock price and volume charts, looking to predict where the other investors will put their money and beating them to it.
There are certainly algorithms nowadays doing this, but they are certainly not limit to HFTs, and have been around for much longer.
By reading just a few posts at the bogleheads.org forum one will quickly see that a ton of people overweight small caps and value stocks (and often the combination of those two factors, small cap value stocks). Some use an S&P 500 index, some use total market. Some hold international indexes (in their different flavors too - developed markets, emerging markets, total intl market, intl value stocks, etc.). Some overweight REITs in their portfolios. The combinations are infinite.
I personally believe that even if everyone indexes we'd still see significant activity in the market because not everyone indexes the same way. Also, a lot of indexers like to dedicate a portion of their portfolios to active investing once they reach a certain net worth - I myself plan on doing so.
The bottomline is that criticisms of indexing are either made out of ignorance or fear, or they have an ulterior motive behind them (such as promoting a firm's actively managed mutual funds).
Tell it like it is. The private retirement system was rigged to begin with, with sole purpose to line the big banks' pockets with management overhead uncorrelated to the performance of the funds.
Quote Goldman Sachs more. Let's see how seriously your source holds up the next time they orchestrate the collapse of the global economy and come to the taxpayers for handouts.
Obvious explanation: the banks packaged in index funds are the largest banks. People don't tend to switch banks all that often, so larger banks charge larger fees to take advantage of their existing customers whilst smaller banks offer better deals to get customers. The explanation in the article makes no sense; it's in shareholders' interest that the banks they own shares in make as much money from customers as possible. (Also, since either outcome could be used to justify their conclusion, this is not science.)
To the articles credit, they linked the study they are talking about. I am still downloading the pdf, so can't say anything concrete yet.
> A market with more passive investors than active ones will continue to push money into the largest firms, whether these companies are actually performing strongly or not.
When I buy an index fund holding the S&P 500, none of those businesses get my money, My money does not go into any of them. I have bought an already existing asset from another person who is selling it.
If anyone could come up with a method that consistently beat passive investing, the situation would change in a heartbeat.
The thing about competitive edges is, if you share them with everyone else then that causes them to disappear.
It's called the Principal-Agent problem IIRC.
> But perhaps we shouldn’t be shocked if an investment method that encourages us to use as little discernment as possible ends up being too good to be true.
... are we just not going to mention that no one beats the market forever, so the intentionally simple, though counter-intuitive, decision might be the right one?
Yet, if so, we should see unreasonably high PEs for big companies (particularly the ones in the Dow).
Why isn't that the case?
http://www.pragcap.com/passive-investing-isnt-hurting-the-ec...