Hacker News Reader

This is a real misunderstanding of how markets work. An index fund invests in everything, market-cap weighted (usually). This means that your investment merely reinforces the prices already determined by the other participants in the market. There are still huge numbers of active managers, not to mention quants and others. They, collectively, determine the prices of assets. When you invest in an index fund, you're just saying "I'll have what they're having", basically. It doesn't cause amazon to rise in price. Lots of companies are in the S&P 500, they don't have returns like Amazon does. Amazon has those returns because people allocate capital specifically to them, i.e. non-index investors.

> And by we, we mean the fat cats who are taking in that investment money you're giving us. You'll make a meager return, but we'll make oh so much more.

Index funds are the least fat-cat-remunerating route you have available to you. They have lower expense ratios than you'd be able to achieve on your own, unless you're using a free service like Robinhood (and if you do that, you're probably paying in other ways, like poorer execution prices).

> basically. It doesn't cause amazon to rise in price.

Yes, it does - you cannot add capital to a market without raising the market cap. It doesn't cause it to raise higher or faster than it's index peers, but it absolutely does cause it to rise.

It doesn't cause it to rise in price relative to others in the same index.

But these strategies do have all sorts of side effects on the market.

It pushes the correlation between stocks up. Investors might be more hot handed as their investment is more liquid, which may result in more selling in a dip. There are all sort of algorithmic strategies that are pro-cyclical. And also it reduces discrimination between stocks which results in weaker stocks benefiting from just being in the index and being overpriced.

> It pushes the correlation between stocks up.

Citation needed. I seriously doubt that this is true.

> And also it reduces discrimination between stocks which results in weaker stocks benefiting from just being in the index and being overpriced.

Not really. Retail investors allocating their money to index funds just leaves the price-setting power to the professionals, which, on net, ought to be better for price discovery anyway.

First result on google:

https://www.bloomberg.com/news/articles/2018-09-09/asia-stoc...

But it is kind of intuitive anyway. ETFs are becoming significant in volumes, so when net volumes buy or sell them, they force the sponsor to buy/sell the whole market reducing price discrimination. To have any price setting power you need large volumes.

I don't see anything in that article that supports your point. Can you snippet out the part that you think does?

You most certainly can. The market cap (current price) is not a function of the amount of capital put in. You can put $1M into a company and have a market cap of $1B or put $1B into a company and have a market cap of $1M.

You're saying that an increase in demand won't increase the price. Obviously there are other factors that affect the price too but being in an index fund is absolutely one of them.

No, I am saying that that same demand impacts everyone in the index equally. That's the point of an index fund.

> basically. It doesn't cause amazon to rise in price.

Actually, it does. Whenever a company is added to one of the major indexes, it almost always increases in price, and conversely, when one is removed, it generally declines.

This is specifically because of all of the index funds that suddenly must put money into/remove it from the stock when it is added/removed from the index.

Supply, Demand, price curves, you know the rest ...

But are those short-term artifacts or do they persist?

As long as stock prices are set fundamentally by deep-pocketed institutional investors buying and selling, a stock's price should only be based on expected discounted future cash flows, no?

I can understand a short-term effect if demand suddenly skyrockets, but that can only last a few days, no?

I'm struggling to reconcile traditional supply/demand with the efficient-market hypothesis here.

Yes, but it impacts everyone in the index equally. Index funds are not responsible for amazon in particular's performance.

around the time they add/remove Amazon (or company X) to the index, they do enhance or detract from it's performance.

Of course, when't it's there for years, it merely adds a relatively steady-state chunk to their price, affecting the level of their price curve, but not so much the slope.

Yep, true. My point is just that indexing has nothing to do with Amazon's meteoric rise. Nor does it make the market less efficient or any other such nonsense.

Yes, I'd guess the effect in the single-digit percentages, and being in the index didn't help GE not get dumped.

Interesting question about market inefficiencies. Again, while they're not zero, I'd guesstimate them to be in the minor percentages...

If Amazon suddenly adjusts their R&D spend to show the massive profit of which they're capable, or does a massive increase to go after a new market, I'd expect it to go up or down massively more than the index and drag the index along. In that respect, the index may play a dampening effect, as people invested in index funds just go along for the general index ride instead of jumping on/off the AMZN bandwagon.

Ya, if I had to guess at an effect I think that'd be it too. It ought to dampen hysteria, by keeping retail investors out of the market for the most part.

This is true, but it also means that they don't fall as much. No matter what the results, the index funds will not sell, so it means the market doesn't change as much.

That's sort of true, but it's an over-simplification. People with capital and conviction can still short heavily. What it does is dampen the emotional swings of retail investors. So, for the market as a whole, volatility should go down as indexing becomes more popular.

> You know what made Bezos so rich in spite of a company that doesn't make much accounting sense? When everyone is betting on his success by blindly investing in index funds.

Let's see...

AMZN: up 62.93% YTD

S&P500: up 6.81% YTD

I don't think index fund investors are the cause of Amazon's growth.

My theory it is QE and maybe Roboinvesting.

We've been (slowly) raising interest rates for the past few years. And even if it were QE, why would it (and robo investing) affect Amazon 10x more than the broader market?

Well, not all of it. I also think Amazon is a good stock for many reasons. 10x seems like a stretch though, many other tech stocks have seen similar yields.

>I don't think index fund investors are the cause of Amazon's growth.

Sure they are.

Index funds are not equally weighted. Practically every tech ETF you can buy has Amazon weighted in the top 10, sometimes over 10% of total assets [0] whereas the average for other securities is below 1% at the most.

[0] https://money.usnews.com/funds/etfs/large-growth/invesco-qqq...

The OP cites "S&P 500 or some total market fund", which are market-cap weighted.

Irrelevant. The market cap is still affected by large scale automated passive investing.

What do you consider equal weighting? Amazon is the second most highly valued public company in the world, should it be counted the same in the index as Fossil Group (one of the smallest S&P 500 companies with a market cap of $1.15b)? To me that would make no sense and would make you hugely underweight AMZN and hugely overweight FOSL.

[edit - sorry, read that as amzn not causing index growth]

FAANG+M probably has a disproportionate impact on the index

https://www.cnbc.com/2017/07/28/fang-tech-market-concern-vol...

>But the Street's favorite stocks have outsized clout in the index. For instance, Silverblatt says the FANG names — Facebook, Amazon, Netflix and Google parent Alphabet — equal about 7 percent of the S&P 500. With Apple, they make up about 10.6 percent.

That's simply because they are some of the biggest companies in the world. It's really the other way around, big tech is dragging the indexes up, not the indexes dragging up big tech.

I see a lot of issues here

You are conflating the general notion of index funds with the common investing advice of buying and holding index funds. I would argue that holding here is the vast majority of the advice. Plenty of people day trade index funds. You should be explicit that your objection is to the un-informed buying and holding of index funds. Also, you should be explicit in how you think a crash would come about, instead of simply mentioning a popular investment category.

Index funds do not discriminate. I don't understand how you drew the connection between them and an individual company like Amazon.

You make the assumption that people who now buy index funds would otherwise be intelligent investors that would correctly set stock prices. I doubt it. The trading patterns of most people have to be near random, more noise than signal, and likely very emotional. In fact, in this way index funds reduce the chances of a crash by removing this kind of nervous money from the stock market.

You make the assumption that index funds would swallow up all investments when in reality the edge that active investors have increases as the number of active vs passive investors decreases. There is a self-balancing force at play.

You simply have a wrong outlook on index funds. Buying a total index fund is investing in the entire stock market; betting that it is healthy and will grow with time. That's all. It is as much "too good to be true" as a healthy economy. Yes, buying an index fund means not participating in the process of correctly allocating resources to the best companies. But the important thing is that you are not in any way harming the actual participants because you obey their prices. This means you are essentially investing as the average active investor.

And lastly, it is naive to think that "fat cats" take more money from passive investors than they do from active ones.

For the discussion in relatively high quality formus like HN to survive there needs to be new rule adopted: Nobody is allowed to criticize or discuss the title of the article. Only the content in the body of the article.

These titles are usually written by editors who think in clicks and they are not the original titles from the writers.

This was good and interesting article but unless we discuss the content (and read it) there is nothing to say.

Many readers at HN find posts with interesting titles, skim the comments, and then read the article. Discussion of the title is useful for them, because if a commenter reveals that the title is misleading, the reader might choose to read something else, or approach the article with a different frame of mind.

Point being: there is some value in discussing the title. Certainly different readers value that discussion more/less than discussion of the content.

> because if a commenter reveals that the title is misleading

This is rarely the case.

Usually (as is the case here). The commenter uses the title title as a statement and criticizes it directly, not it's relation to the article.

It seems to me that people read the title, and come here to comment the title before reading the article.

I've got 27 points on the first comment of this article [0] talking somewhat about the title and 8 points on my follow up about how the title is misleading so some people including myself definitely think the title is important.

[0]: https://news.ycombinator.com/item?id=17941804

Looks like investor Bill Ackman, famous for shorting the housing market before the bubble burst, had the same theory back in 2016. It's an interesting perspective.

https://www.marketwatch.com/story/bill-ackman-actually-had-a...

> famous for shorting the housing market before the bubble burst

Also famous for losing more than $3 billion (or $7.7 million per day) on Valeant

http://fortune.com/2017/03/15/valeant-stock-bill-ackman/

Famous for taking big risks that sometimes pay out and sometimes fail dramatically.

Taking big risks is only laudable if you win.

https://assets.pershingsquareholdings.com/media/2014/09/1712...

Oof. Up 1% over a time period where the S&P is up 118%. Brutal.

Active funds generally underperform during periods of economic growth and we're in the longest running bull market of all time right now. Ackman makes mistakes but he is still very insightful and backs his opinions with dollars. No one who deals with risk is going to have a perfect track record, and even though his Valeant and Herbalife bets didn't pay off the opportunities/flaws he saw were real, other factors just happened to be more important such as Icahn propping up the price of Herbalife and Valeant's accounting problems.

Index funds don't necessarily need to react to price changes.

If you have 2 companies A, B worth both worth X billion each and you own 1 billion$ of each. Then if A's value doubles you now own 2 billion$ of A and 1 billion$ of B which is also the correct ratio.

If you bought an actively managed fund 30 years ago, it was literally an index fund with more fees attached. Active managers actually just index, but try hard to obfuscate this fact to justify their high fees. If you dive into their books, they are basically buying the market. I think it begs the question, how active was/is active?

The math is clear, you are statistically unlikely to beat the market.

Some of them do beat the market. They are also producing returns that are more robust to a downturn. So even if they dont match the S&P performance, in a downturn they dont lose as much as the S&P does. It's difficult to compare index funds to hedge funds, they have different purposes. When the market is always going up, it looks like a scam.

Hedge funds are also statistically unlikely to beat the market and finding one that does requires a huge capital buy in that few workers can make. You're talking 250-500k minimum buy in. Hedge funds have chronically underperformed for the last 10-15 years. Now that so much information is available, much of the market performance is priced in now.

Once again, the best bet for the average person is an index fund. On a 30 year timeline all of these blips are smoothed out. If you can afford top level financial firms you're probably way wealthier than the average person.

Did they beat the market because they are actually better investors, or did they just get lucky? There are so many hedge funds now that statistically a few of them are guaranteed to have long lucky streaks.

If you could decide this accurately, then you would have a strategy for your own hedge fund.

But, what if everybody only buys index funds and there arent any active players anymore ? I am not an expert in this field, but I do feel that the passive nature of index funds has been benefiting greatly from the actions of active investors.

No one really knows, to be honest. But, many "active managers" were indexing before indexing was widespread, so it's unclear how much of a real change this is. Even hedge funds use index funds to back some of their riskier moves and it's common to use a blend of indexes and shorts. It really begs the question...how active was active before wide spread indexing?

It's not really as binary as many perceive. It's not as simple as active vs passive. The future is probably some kind of balance between active and passive.

Yep, if everyone went passive, it would probably become a problem. But currently, less than 18% of global stocks are owned by index investors [1]. And there's likely an equilibrium point between 18% and 100%, where both active and passive investment make sense.

[1] https://www.reuters.com/article/us-funds-blackrock-passive/l...

The more people invest in index funds, the more opportunities for active investors. The market balances itself naturally.

If everyone invests passive, you could make a ton of money by buying companies which are worth more than their stock or just give you an extremely high dividend.

A company's dividend has zero bearing on the fair price of its stock. Profits do, but that's a separate decision from dividend. Any money a company makes is either invested in growing the business (increasing the stock's value), or returned to investors, and as long as the investment makes economic sense you don't care either way.

Dividends vs stock buybacks are a wash economically - if you look at cash flows, they both reduce the market cap by the cash given to investors. It's just that dividends reduce the price of the stock directly, while buybacks reduce the number of shares outstanding.

> It's just that dividends reduce the price of the stock directly

Dividends reduce the price of the stock directly because there is an active market. Once the dividend is paid out, the stock price is decreased by the dividend because this is what market makers are willing to pay now.

Without any active market, paying out a dividend would not influence the price, because there are no market makers to begin with.

This is of course absurd, so there will always be an active market.

Philosophical Economics has a thoughtful essay on this: https://www.philosophicaleconomics.com/2016/05/passive/

I’m going to argue that the trend towards passive management is not only sustainable, but that it actually increases the accuracy of market prices. It does so by preferentially removing lower-skilled investors from the market fray, thus increasing the average skill level of those investors that remain. It also makes economies more efficient, because it reduces the labor and capital input used in the process of price discovery, without appreciably impairing the price signal.

I think I'll listen to Warren Buffet's advice on index funds.