If there is a big swing in either direction. Some stocks will get way overvalued or undervalued compared to their intrinsic value. Maybe this is beneficial to a value investor that picks stocks instead of investing in ETF's? I wonder if ETFS will make the market drop a lot in the next crash and will the etf's even track their underlying accurately? Lot's of arbitrage opportunities.
Probably with put options.
https://www.zerohedge.com/news/2017-04-09/horseman-global-un...
ETFs were an outstanding idea but never meant to be used on such an excessive scale. If once stock falls and many of the ETFs have to re-balance their index to reflect this, this creates a feed back effect. And if Index ETFs and HFT are the last ones trading this stock, good luck with this.
Everything works until it doesn't.
State of the world
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Market caps A=$1B B=$1B
Fund holdings A=$10M B=$10M
Market caps A=$1B B=$0.5B
Fund holdings A=$10M B=$5M
The only time a fund needs to rebalance is when a security is removed from or added to the underlying index. I don't know how that is handled, but I suspect it is predictable and priced in.
Won't they need to rebalance then? The way it will happen is they will have to sell all the stocks in the ETF according to their percent allocation
[1]: https://www.etf.com/etf-education-center/7540-what-is-the-et...
Assuming no entries or exits into a cap weighted index, there will be no trades. No trades mean no price pressure either way. So it would just be the active traders exerting price pressure. And index buyers and sellers would buy and sell everything which wouldn't misvalue any one stock.
I mean if everyone piled into the market, you would still get a bubble sure, but that would imply that at least some stocks were misvalued anyway, so we still aren't worse off.
'Intrinsic' value starts getting tricky very quickly. How do you go about defining it. You're implying it isn't the stock price, so assets minus liabilities? But then what about Uber, or Tesla.
What arbitrage opportunities are you making reference to? ETFs are basically valued via arbitrage, certain traders are allowed to swap the ETF for the basket of shares, or visa versa, so if the price moves away from the underlying shares, they arbitrage it away.
If the market is crashing then the bid ask spread is going to be very wide but i guess same will be true for common stocks. I think it is important to invest in high volume etf's like qqq/spy. So yeah you are right, arbitrage opportunities are still there i just think that during downtrends there will be more but in that case who cares about arbitrage! The best strategy is to go short.
Has this ever been observed to be the case? We have had moments of extreme or at least high volatility in the recent past and I don't recall any news articles about how VTI diverged from VTSAX. That being said, even if such a thing did happen, that would only affect people who trade the ETF during those moments of volatility, right? For anyone else, the only risk is that people would be so scared off of the ETF that there would be insufficient liquidity to restore the price to the right point. Even then, an authorized participant will eventually buy up the under-priced shares and redeem them.
It's worth pointing out that vanguard at least do a Value tracker. I suppose theres discussion to be had over whether it's 'passive' but I guess it's included in these figures.
Short selling tends to be a losers game, stocks go up more than they go down, so I wouldn't recommend that, but yes they aren't value stocks. but then my moneys in index funds, so what do I know.
I'm sure this is not overlooked by everyone who is trying to do better than the index.
I've built my portfolios exclusively on mis-/un-priced risk for a very long time, which has always performed well, but in my experience it is easier to find these opportunities today than it was many years ago, likely due to a combination of factors.
There are also cultural and social elements. The pendulum has swung so far toward indexing being the "correct" way to invest that there is a bizarre amount of hostility out in the world toward people who assert it is possible to have consistently great performance without index investing.
I think the hostility comes from the fact that such individuals almost always make the assertion sans evidence, and often stand to make money from suckers -- in the gambling sense, i.e. people who don't know the odds -- who believe them and trust them with money. I'm sure if someone demonstrated their ability to outperform the market prospectively, and also were willing to accept outside investment, they would have people knocking down their door to get in. However, there is no entity with a long track record of outperforming the market that is both open to outside investors and claims that they will continue to outperform with a high degree of certainty.
Aside: the people want to know 1. how long you have been investing 2. the rough amount of assets you have invested 3. what your annualized rate of return is over the period mentioned in question 1. Not that this would prove anything, because anyone can claim to have had 25% ARoR over the last forty years, but it would at least be interesting to know what the claimed performance is.
I'm a long-term risk modeler, originally for fun and later for profit. I build portfolios of US large caps based on categories of risk that are not priced into the market because they are difficult to model in a conventional way. This is an entirely uncontroversial way to outperform indexes but you wouldn't build a public investment vehicle around it. My oldest continuous portfolio goes back to the turn of the century, at around 20-21% ARR (more recent portfolios are a bit better). Per year, it requires maybe several hours of my time. I have a few friends and acquaintances that seem to do a bit better (but also spend more time on it) that also trade on un-/mis-priced risk, often as a justification to polish their data science skills, across a variety of asset classes.
I am not saying it is trivial to consistently outperform the indexes, just that the difficulty is significantly overstated. The hurdle most people trip over is that there are no shortcuts to figuring out how to build your own models from first principles and how to trade them.
The difficulty isn't overstated because in aggregate it's mathematically impossible. The total market return is zero-sum so someone else has to take the other side of your bets and lose return. That someone else is not me, I'm getting the market average consistently to within a decimal point from my index fund. Here's Sharpe's simple take on it:
For anyone who misreads the subtleties of your post and thinks they cant make consistent alpha through active management. They can, but (without knowing anything about them) probably won't.