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There are a huge, huge number of people that have 401ks and IRAs that only offer a small number of actively managed mutual funds, many of which have high fees, and there is little consumer education about the high of these fees. If this rule change leads more 401ks to offer ETFs and some education about there value, it will make a big difference.

> I can't think of a single reason that anyone should have any money in an actively managed mutual fund.

I kinda agree with you. However, theoretically, I would have been more than happy to put my money in an actively managed fund IF that fund was managed by someone with a very high intelligence and who was able to sit still. By sitting still, I mean not buying and selling all the time. Often, it's far more profitable to sit on shares for many years, rather than buy and sell all the time. But I guess those fund managers are expected to come into some office every day at least from 9 to 5, regardless of whether there is anything to do. Also, they probably have co-workers and bosses who ask them what they're doing. Maybe it would be kinda boring to answer "nothing" every day for like 2 years in a row.

Just to check, As a newcomer to finance, what hedge fund managers add?

I watched a documentary recently that suggested that they gain % for every X period they add value (over risk-free rate?), but don't pay back any % for losses they make? This the situation?

The classic hedge fund used to be able to find niches in the market where they could make money - and the good ones used to be able to do it well.

They could do things other money managers couldn't - short stocks (i.e. hedging against a fall, hence their names), better analysts, investments in more diversified instruments, early HFT.

They would often take a fee of two and twenty - that is to say 2% of the money you lent them (every year), plus 20% of the profit they made from that money.

If you gave them $10 million, they'd take $200k as a fee every year, then 20% of the profit they made. So let's say they made you $1 mill a year, they'd be paid in the first year $200k fees and $200k performance fees.

However nowadays there's millions of them, and almost all of them lose money as there weren't that many profitable niches to begin with, and a lot of them were lucky anyway (survivorship bias).

The vast majority of hedge funds have high water marks on fees now. I'd love to see the source on "almost all of them lose money" - since my experience doesn't tie up. I'm assuming you're talking about returns vs passive indexation after fees?

Of course any reported results on hedge fund returns are kinda funky for the reason of bias that you mention.

There have been several studies out of 100 hedge funds ~20-30 percent beat passive funds after fees in a given year. However, next year the results are random. So, that % drops as the time frame increases.

Survivorship bias is huge in this industry. There have been plenty of funds with awesome runs, but few have lasted 20+ years.

PS: The financial industry also loves to point at old funds as being above average while quietly killing off lot's of tiny funds and growing others over time. IMO, this goes past survivorship bias and into the old con where you mail 1024 people the results of a game, then 512 people you got right, then 256... Until you have great history with your last sucker.

Do you have links to any of them out of interest?

There are hundreds of strategies in hedgefunds from HFT to Macro to volatility trading to commercial ground rents to God Knows What™ - so I'd really like to see what was being done for this kind of analysis (and who by and what data they had access to).

Past performance is a lot like the false positive problem in medical testing. A 99% correct test on a condition affecting 1% of the population is not useful. Similarly looking at past performance for a hedge fund is a poor way of identifying those with "alpha" (if you believe true alpha exists at all, which is entirely dependent on your point of view).

Take Mr Buffet as a spurious example. If he leaves the fund, it won't affect past performance for some time. So do you want to buy into B-H without him - just because it used to make money? Or would you go into his new fund because you think he has a process that works.

If the fund manager mostly does nothing, what value does he provide?

Picking the initial stocks? A company like Berkshire Hathaway run by Warren Buffet has a very low churn over the years, especially in their larger positions. The company has been sitting on 400,000,000 shares of Coca-Cola since the late 80s, never selling a single share.

Guards standing at the gate also do nothing 99% of the time.

Good sysadmins as well.

It is such a cool principle. I think it can be extended to all manner of fields. As a process engineer, I am convinced that the best machine operators are the ones actively doing nothing. The active bit is key: they must be alert, watchful, understanding, and for-God's-sake don't push nothing unless you need to.

Somewhere along the way operators think that if they don't push a button every fifteen minutes they aren't earning their pay (I blame bad management and production pressure). So when in doubt, look busy. It has awful and confusing effects on processes, leading to long term hard-to-diagnose noise in otherwise stable systems.

I think the same principle applies here. We want vigilant, patient, and wise did managers. Not just super active and excitable ones.

ETF have one big problem, you end up with a critical mass of investors who all apply the same know rule based investment strategy. That means that they will be arbitraged by hedge funds (like when a stock is expected to enter the S&P, you know there is a huge mass of dumb buyers who will buy it then whatever the price). And you are creating potentially liquidity issues. You need people with various trading strategies for the market to remain liquid.

I am not against ETF, in fact that's what I would use, but it comes with its own problems.

This "problem" isn't confined to ETFs - its relevant to any fund (mutual fund, ETF, etc..) that tracks an index. ETFs only have about $2 trillion under management. Compare this with maybe $20 trillion under management in the mutual fund space. Though, not all mutual funds are passive index funds. Movement of stocks in and out of indices doesn't really create an issue. But it does setup an opportunity for arbitrageurs.

If you have enough market makers trying to arbitrage you, they compete, so you can buy the stock that enters the S&P 500 for a reasonable price.

The other way round, the more they arbitrage me, the more I buy dear (they front run me and push the price up).

I think eru is right. Here's my argument:

Tomorrow I will buy 10 shares of XYZ at any price, and everyone knows this. XYZ is worth $100/share and today that is the price. If one other person in the world owns XYZ shares they can sell it to me for $200,$300, whatever price they name. If 2 people own shares, there will be competition, and I'll buy at the cheapest price available. If 1000 people own shares I will still have to pay more then $100, but if there is true competition on price then I should only pay slightly over $100.

That's not the way I understand the arbitrage, you are assuming hedge funds have no impact on prices.

Say company X is getting bigger, and pretty much qualifies to get into the S&P500 at the next revision of the index, it currently trades around 100.

When it gets into the S&P500 all the ETF buyers will buy this stock, that will push the price up to 110. Some of them will buy it at 100, some will buy it at 110 and some anywhere in the middle.

Now a bunch of hedge funds anticipate the ETF will do that and start buying it ahead of the stock going to the index. The price of that stock will rise to 102, 105, perhaps 107 if you have lots of people doing this arbitrage.

When the ETFs buyers pile in, they will be picking up the stock somewhere between 105 and 110, not 100 and 110.

Now one can argue this is the problem of the bank maintaining the ETF, because as far as the ETF investors are concerned, they own something that tracks the index, if it costs more to replicate the index, it is not their problem. But the way I see it is that the new stock will enter the index at an inflated price, and the price will converge again to the fair value when all the buying is done (instead of the price going up after the stock joins the index and converge again). That means that the ETF investors will have a lower performance than what they would get if no one was arbitraging them.

The index-tracking-fund managers are well aware of this. There are comments elsewhere in this thread detailing some of the strategies they can use. This has also been going on for a while, see: https://news.ycombinator.com/item?id=9844686

"As someone who is on the side of actively managing money, I see this as a strong positive. The more passive money there is sloshing around the more arb opportunities there are!"

In the medium term active and passive management will eventually reach equilibrium. Passive funds cannot perform price discovery as well and rely on active funds to do this. However the ability of computers to discover prices will eventually exceed that of humans not possessing insider knowledge. My money is, literally, with the computers.

The problem of market pricing in the economy is NP-hard. It's means as a human if you're good you'll always have a chance. At the very least you can pull moves like "1. buy a big stake in the company. 2. Kick out the directors. 3. Do a better job". which computers will not be able to do for quite a while.

I don't see why you're being downvoted. Here's a reference for market pricing being almost certainly NP-hard: http://arxiv.org/pdf/1002.2284 "Markets are efficient if and only if P = NP"

This paper's claim that finding an effective technical trading strategy is in NP relies on the search space for technical strategies being exponential in the length of history being considered (which it's not -- that's the size of a description of a single strategy) and the tacit assumption that historic performance of a strategy guarantees future performance.

Because of the assumption of there being a correct answer. It is as much a problem of definitions and arbitary valuation as anything.

An academic analysis like what you linked to has to assume everybody have settled on the same definitions and valuations.

That's true of all analysis. We can't even calculate 1 + 1 if we are not going to agree to the definition of the plus sign.

See my other comment describing what a perfect answer looks like.

There's a good argument to be made, that doing the market is harder than NP.

Market pricing can't be NP-hard -- if it was, that would mean there was a perfect answer, we just might not have to computing power to calculate it.

I solve huge NP-hard problems every day, I've never seen any suggestion there is a useful way to solve marking pricing.

The problem is thus: How to price every good and service at equilibrium in the economy, with regards to the marginal cost and marginal benefit of every individual for every good and service.

You have not seen any suggestion to solve this problem, does not mean it isn't NP-hard.

>> we just might not have to computing power to calculate it.

There is a perfect answer, and there will almost never be enough computing power to calculate it. It is always approximated.

Keywords being cost, benefit and every individual. Those are all big variables. Everybody will define what the cost and what the benefit of everything is differently, both from their own perspective and from the perspective they perceive that others has/should have.

So you'll have more "perfect" answers than people, and no way to select any one of them.

That's like saying if you don't have a GPS the travelling salesmen problem isn't at least NP complete because you don't know what the weights are and every edge has a different weight, which would screw with your calculations.

It's not a valid argument against the fact that everyone does have their marginal benefit and marginal costs for every good and service that can translate to a binary decision of whether they would purchase a good or service at a given price.

Just because you can't see it doesn't mean it's not there. And I'm not saying it's impossible to find out individuals marginal benefits and costs, because in markets you very well can. Stock traders, when evaluating whether a stock would go up or down, would often buy a bunch of stock, see how the market takes it, then sell a bunch, and by measuring how fast the market eats his orders, he can estimate the aggregate marginal benefit and cost of holding the stock, and then speculate accordingly.

> the fact that everyone does have their marginal benefit and marginal costs for every good and service that can translate to a binary decision of whether they would purchase a good or service at a given price.

I think this fact is more like an axiom.

An easy way to check if you have an NP-hard problem: If I give you the right answer, can I easily convince you that the answer is right?

With NP-hard problems like Sudoku, that's easy. Slightly simplifying, the definition of NP-hard is "easy to check the answer, hard to find it".

A problem being NP hard doesn't mean that humans are competitive against computers. I'd like to see you solve SAT instances faster than cryptominisat, or do linear optimization better than Gurobi.

We have more of a chance solving complex problems better than AI, than if we were solving "simple" problems like chess, or even, Go.

EDIT: Added rabbit ears for simple.

Those are not simple problems. Generalized Chess is EXPTIME complete, so I'd say it's pretty hard.

An advisory service could recommend a hostile takeover, but not execute it.

You don't need to solve an NP hard problem to beat human intervention. You just have to be faster and more accurate.

I do think that computers could outperform humans on the supply side, calculating the costs of production relative to competitors better than humans. The demand side is trickier but again computers would do a better job calculating available cash and then ranking marginal goods' likelihood of being purchased based on existing prices.

As long as prices and production processes are public knowledge computers will do better than people at modeling the economy. Humans only gain an advantage through insider knowledge and trade secrets.

>The problem of market pricing in the economy is NP-hard.

Is it? I mean, I see how it's reflexive (and so chaotic) but NP-hard is the halting problem: given a program and it's input, decide if it halts. E.g. what is the input to your market function? It's like asking if the world halts.

The thing about all complexity analysis is that it ignores input/output.

NP-hard is the class of problems that are at least as hard as NP. The halting problem is in there, but it isn't decidable _at all_.

Just that its NP-hard doesn't mean it's as hard as the halting problem, it could be easily decidable in exponential time.

Complexity analysis is all about the size of the input, it doesn't ignore it.

> I can't think of a single reason that anyone should have any money in an actively managed mutual fund.

It will depend on your bank, but anecdotally it seems commission free mutual funds are more common than commission free ETFs. If you are the type who wants to invest X% of every paycheck (i.e. making multiple trades a month), are only investing a small amount of money, or are only investing for the short to medium term, you are likely better off with the the higher fee and lower commission. Retirement savings tend to be none of those three categories, so ETFs are almost universally better in that regard.

My understanding is there is no fee when putting in money towards your Vanguard Index Fund. I don't think they charge any extra money per transaction. You probably get screwed a little based on how quickly prices update and what price you pay per share (I don't know if you do but I'm just guessing). However, as people who don't have a day job in buying and selling financial instruments, I think we are probably better off buying and holding. And hoping and praying the US economy and the world economy will overall grow in the next fifty or so years.

https://personal.vanguard.com/us/whatweoffer/stocksbondscds/...

> If you are the type who wants to invest X% of every paycheck (i.e. making multiple trades a month), are only investing a small amount of money, or are only investing for the short to medium term, you are likely better off with the the higher fee and lower commission.

Roboadvisors like Wealthfront solve this problem more elegantly and at lower cost.

Generally I agree with you. However I can provide a personal counter-example. I am a student with a modest sum saved away (with great help from my parents) in an index tracking mutual fund. Due to the way my bank offers investment packages, I am far below the minimum portfolio balance required for significantly less fees. However, I can have a mutual fund in a different type of account offering which is essentially the same as an identical ETF.

This is (Canadian) RBC - Direct Investing.

In addition this particular fund also significantly outperformed other ETFs during 2008-09.

Questrade in Canada lets you buy ETFs for free, as little as one share at a time. You only pay when you sell ($0.01 a share, minimum $5 a trade).

Anything sold by the big banks in Canada is almost always a ridiculous rip-off.

Even better might be something like Wealthsimple.

(Not affiliated with either company except as a customer)

Friend of mine work over at WealthSimple. Glad to hear people like it.

Outperforming the market in bear years is the main reason in keep some of my money in managed funds.

Is the statement "more passive money implies more arbitrage opportunities" actually true?

1. I think passive money is generally not taking any position on whether an asset is over or under priced, and as a class tends to be very inactive. I doubt it either increases or decreases arb that much.

2. I think what would increase arb opportunities would be:

A. A critical mass of misinformed active managers

B. So few active managers that the market is gameable

However, as the number of active managers decreases, one would think that the misinformed ones would go first (A), and that (B) won't be a linear progression, but a sudden tipping point at a very low level of active management.

Actually, I sort of think the final statement is reversed. As the number of active managers declines, and the average active manager becomes more competent, it will become harder for the active managers to find profitable arbitrage opportunities.