Index funds officially overtake active managers
finance.yahoo.com
finance.yahoo.com
What's the argument that active managers aren't just rent seeking parasites lying about their roles? Why have active fees gone down if they provided value all along?
"That might be true of other active managers - not me though, this fund I manage has outperformed the market over the past 10 years."
You can’t really do anything about this even if you’re actively aware of this mechanism and think it’s fundamentally over valued.
It’s like a decentralized Ponzi scheme
It basically magnifies wealth discrepancy which is what the sociopaths want. The rest of us just try not to become poor by playing their games. Whenever everyone gets too close to fair, they invent a new game, or take the ball and go home. You know? I'm only sort of kidding. :D
who is “they”?
Like maybe we didn't kill the neanderthals, you know? I think we probably convinced them to kill each other. That's kind of our specialty.
It might be the inverse. Someone not wanting to get out of bed in the morning projecting that view onto the world.
Look up Social Darwinism. Broadly: most evolutionary explanations for social behaviour aren’t science. They’re parlour tricks. One can posit reasonable-sounding explanations for any behaviour, real or hypothetical, none of which is testable.
Example: I can construct individual-selection arguments for humans being evolved sociopaths and group-selection arguments for humans being collectivist sheep. There is truth in both statements. But their predictive value is totally dependent on the immeasurable mix and mechanics thereof, all of which is blissfully ignored, both in substance and evaluation, by this framing.
I value the time you put into explaining your position, however I dont think creative thought exercises like trying to explain why wall street is full of a-holes using evoluton is a parlour trick. Because there's no trick. It's just a thought. On a discussion forum. Where people discuss things.
There is a trick. You're claiming artistic license as a fictional narrator. That's fine! That's a thing!
But it doesn't work when presenting explanations for the real world. One in which the stock market is a "scam" whose "primary value" is "to keep the sociopaths" busy while it "magnifies wealth discrepancy which is what the sociopaths want" all while if someone other than "they" start winning "they invent a new game, or take the ball and go home" [1].
Evolutionary explanations of sociology have a long history of being deeply flawed. At best, they're arbitrary [2]. As explanations for the present state of the world, they aren't useful. As fictional devices, sure, why not.
[1] https://news.ycombinator.com/item?id=31469336
[2] Caveat: evolutionary thinking works when one starts with real-world observations and supposes how they evolved. Cf: the evolution of altruism in humans [a]. It fails when one supposes evolutionary pressures to predict human behavior, e.g. natural selection and social competition exist, herego we should expect our leaders to be sociopaths. Observation, not supposition, before conclusion.
And since we're quoting each other, you opened with, "It might be the inverse. Someone not wanting to get out of bed in the morning projecting that view onto the world." I assure you I love getting out of bed. On the other hand, I kinda get the vibe the discussion you're having is a continuation of one you've had before with someone else and maybe you're projecting it on to me?
I checked out your profile and now I understand! Haha. Fun times. Thanks for the links.
If people know what they're buying, and they later really sell it to a willing buyer without lying to them, that's not even any kind of fraud, let alone a Ponzi scheme.
That's info asymmetry.
Ergo, lying.
Specifically by omission.
So the Ponzi essence is still there.
Have you gone to a shareholder meeting? Submitted a question to an earnings call?
EDIT: Counter offer or decline acceptable. I can go up to $1k on this. I have money in play from this site up to 3x payout. Your call.
Believing passive investing at scale causes irrational rises in price does not mean it’s wise to assume the price will definitely go up or down. It’s obviously not the only effect in the market.
Going long on the general market is a bet that things will generally continue. That’s about it.
In any case, if you don't want to play that's fine. I enjoy this; you don't. No reason to be offended. Offer open to others. Has been taken up in the past. Fun for all.
A Ponzi scheme is a type of fraud where someone lies about where the money paying off earlier investors is coming from - they say it comes from investment in some kind of business or other businesses, but it actually comes from later investors' investments.
The stock market is transparent, it is obvious that when you buy something, part of the return will come from a later investor buying it from you - that's the whole point of buying something.
It's not a Ponzi scheme if there's no-one lying about where the money comes from.
...being the key phrase. There's a long way to go to 100%.
Technically it can’t be 100%, else there’s nobody to buy from.
Many of the heavily targeted companies are at 20-30% index fund ownership.
Note that this has been around since 1980:
> The Grossman-Stiglitz Paradox is a paradox introduced by Sanford J. Grossman and Joseph Stiglitz in a joint publication in American Economic Review in 1980[1] that argues perfectly informationally efficient markets are an impossibility since, if prices perfectly reflected available information, there is no profit to gathering information, in which case there would be little reason to trade and markets would eventually collapse.[2]
* https://en.wikipedia.org/wiki/Grossman-Stiglitz_Paradox
Paper:
* http://www.dklevine.com/archive/refs41908.pdf
* https://papers.ssrn.com/sol3/papers.cfm?abstract_id=228054
Price discovery happens at the edges: you probably don't need a lot activity for it. I think we're seeing a lot of the also-ran active managers (slowly) being weeded out, and the remainders will increasingly be those that actually manage to get things right every so often.
So what you need to track is the net flows. If the net flows are positive, and there is so little active left in the market that no matter what the active investors do the stock still has positive net flows, then active has no other option than to buy. This eventually leads to stocks having an infinite price as there is no downward force. On the other hand, if net flows are negative, then prices go to 0.
Imagine an index, and an index fund tracking it. The index fund will own x% of every stock in the index. Someone buys the index fund, and the index fund now try to achieve x+epsilon% in every stock.
But what if 100-x% of the stock is owned by diamond-hands hodlers, that wont sell at any price? The index fund bids higher and higher, and the sellers refuse to let their shares go, making the price reach ridiculous levels.
The price reaching 0 seems less likely, as there will always be bargain hunters.
And you think short-sellers are going to risk infinite losses? This is a prisoner's dilemma that you aren't going to win.
That's ultimately down to the incentives in place. If the board members have a lot of options in their compensation package, they might prefer to see the stock price climb and climb. In fact if the incentives are set up that way they might do a buyback to help fuel the rise, even at the cost of longer-term harm to the company.
have a read about the creation/redemption mechanism and you'll see why this won't heppen
https://www.investopedia.com/articles/exchangetradedfunds/08...
Who was selling? Recent retirees did well when they sold, but is there more to it than that?
It’s an odd time when cash does poorly (inflation), bonds do worse, and the stock market fell. Prices are relative, though. I guess it’s all relative to commodities and labor.
It seems like increased debt due to higher-priced assets as collateral probably needs to be taken into account too.
Passive investing means something, and what you are saying is not it. From William F. Sharpe, Nobel-winning economist who came up with capital asset pricing model (CAPM):
> A passive investor always holds every security from the market, with each represented in the same manner as in the market. Thus if security X represents 3 per cent of the value of the securities in the market, a passive investor's portfolio will have 3 per cent of its value invested in X. Equivalently, a passive manager will hold the same percentage of the total outstanding amount of each security in the market[2].
* https://web.stanford.edu/~wfsharpe/art/active/active.htm
A "passive" investment strategy is not about not-buying/selling, but rather about not actively choosing particular financial instruments.
> Passive management (also called passive investing) is an investing strategy that tracks a market-weighted index or portfolio.[1][2] Passive management is most common on the equity market, where index funds track a stock market index, but it is becoming more common in other investment types, including bonds, commodities and hedge funds.[3]
* https://en.wikipedia.org/wiki/Passive_management
Following a particular index (NASDAQ, Dow Jones, S&P 500, Russell 3000, Wilshire 5000, TSX, FTSE 100, MSCI EAFE) is passive investing, even if you put in money every pay cheque.
« Passive » funds do buy & sell based on flows and tracking of the index, not to mention when companies IPO and/or drop in/out of things like the S&P 500. Market weighted fund might be a better overall name than passive.
> The terms passive investing and index investing are often intertwined, but they are not exactly the same thing. Today’s guest is Adriana Robertson, the Honourable Justice Frank Iacobucci Chair in Capital Markets Regulation and an associate professor of Law and Finance at the University of Toronto Faculty of Law and Rotman School of Management. Adriana is interested in index investing and, in this episode, we hear her views on whether or not index investing is passive. Hear facts from her paper on the S&P 500 Index fund specifically, and all of the reasons that it's not passive, as well as some of the issues that are potentially arising from the creation of so many indexes or so-called passive investments. A more recent paper by Adriana, published in The Journal of Finance, surveyed a representative sample of U.S. individual investors about how well leading academic theories describe their financial beliefs and decisions, and Adriana shares the differences in something like value growth from an academic perspective versus a real-world perspective. Find out how investors can go about evaluating the performance of their portfolios and what they should be looking for when deciding which index fund to invest in, as well as why index funds aren’t a meaningful category anyway, factors from Adriana’s surveys that might influence investor’s equity allocation, and the trend towards indexing and whether it will overtake active portfolios. Tune in today for all this and more!
The strong efficient market hypothesis combined with completely rational (no-noise) market participants leads to a "no-trade theorem." If anyone tried to buy or sell a security based on new information, other market participants would incorporate that attempt into their information about the market. The notional price would change (bid/ask), but the security wouldn't trade hands.
This is of course absurd in practice because securities do in fact trade, but it tells us that we don't need random retail investors picking stocks with coin flips (or asset managers doing so and charging 2%/yr for the privilege) in order to discover fair prices.
That someone has to set prices and structurally index funds can't do that job. How are prices going to be set without active participants? You could do it by formula I guess, but that would be gamed by companies around earnings time and doesn't account for differences in industries or differences in corporate strategy.
> Why have active fees gone down if they provided value all along?
That's exactly what you would expect as more firms enter providing the same service. The same thing happens in every other market. More competition drives down margins.
(The answer is that they would exploit the inefficiency and the market would maintain efficient price discovery, but they'll get more business by fear-mongering around index funds.)
If your active manager beats the index (in returns and risk) after fees then he is earning his keep both for you and the world in gen
This requires complex daily work and would be nearly impossible for a financial advisor to perform.
Virtus AZNAX is another fund that blends a bunch of financial instruments to achieve a targeted return.
There's plenty others and they're all available from any retail brokerage firm.
Whoever actually believes they have more information than the market and is willing to stake their own money on the proposition. I'd guess that we need surprisingly few of those folks to keep the machinery humming.
I think you copied and pasted your rant from a different rant about finance as it really doesnt have anything to do with this.
That said Berkshire is a pretty poor example as it has a pretty diverse range of holdings, its basically a passive index of its own.
This site says SP500 with dividend reinvested is 270%.
I also feel like SP500 has a lot less risk because politicians are very incentivized to provide a backstop to SP500 price, but not as much to BRK.
Also, BRK is squeaking out 280% vs SPY 270% by being 25%+ invested in a single company, Apple. That is a lot of extra risk for not a lot of extra return.
Matt Levine has a bunch of articles touching on this topic.
[0] https://shareaction.org/news/new-data-shows-scant-improvemen...
Is your kids 529 plan on the S&P. Well congrats - you got to buy Tesla at the peak of Elon’s pump train just in time to be a ticket holder for his self-immolation show.
Does your 401k hold small cap exposure to the Russell. Yippee you get to be the bag holder for a good chunk of the SPAC garbage VCs dumped into public markets based on things like projections that personal electric helicopter taxis would become ubiquitous in US urban markets by 2025.
Passive investing got gamed by Silicon Valley and isn’t exactly what Bogle had in mind when he got started.
Specific stocks being bad investments is not an argument against passive investing. The whole point of index funds is to diversify your portfolio so you track the overall market, not any specific stock or group of stocks.
If you are assuming you know which stocks/sectors are under or overvalued, then I guess active investing makes sense, but that seems like a flawed premise to start from.
This is an interesting and plausible take, just wondering if you have actual published resources on that or is it your personal, arguably justified hunch?
What markets are doing is recording and publishing the results of auctions for the particular good as a time series of data. Indexes hide some of that but there's something far worse: HFT.
The problem is that program trading and HFT has far more in common with the old Scientific American COREWAR game than it does with the fundamentals of price discovery. The buy/sell decisions are about gaming other players rather than discovering price. There are also nonlinear feedback loops with very short loop time constants created that are "nonconservative" in a physics sense and create instablity. The fact that hard limits are required to deal with flash crashes is a warning, not a solution!!
Retail investors’ holdings in index funds exceeds active funds for the first time
More specifically:
> As of March 31, Morningstar says, retail investors had $8.53 trillion invested in index mutual funds, while $8.34 trillion worth of assets were invested in actively-managed funds.
> Over any specified time period, the market return will be a weighted average of the returns on the securities within the market, using beginning market values as weights[3]. Each passive manager will obtain precisely the market return, before costs[4]. From this, it follows (as the night from the day) that the return on the average actively managed dollar must equal the market return. Why? Because the market return must equal a weighted average of the returns on the passive and active segments of the market. If the first two returns are the same, the third must be also.
> This proves assertion number 1. Note that only simple principles of arithmetic were used in the process. To be sure, we have seriously belabored the obvious, but the ubiquity of statements such as those quoted earlier suggests that such labor is not in vain.
> To prove assertion number 2, we need only rely on the fact that the costs of actively managing a given number of dollars will exceed those of passive management. Active managers must pay for more research and must pay more for trading. Security analysis (e.g. the graduates of prestigious business schools) must eat, and so must brokers, traders, specialists and other market-makers.
> Because active and passive returns are equal before cost, and because active managers bear greater costs, it follows that the after-cost return from active management must be lower than that from passive management.
* https://web.stanford.edu/~wfsharpe/art/active/active.htm
And on why picking a winning stock is so hard (first edition 1973):
* https://en.wikipedia.org/wiki/A_Random_Walk_Down_Wall_Street
For instance, if today's active managers always lose their asses to new active managers arriving tomorrow, then any active manager you actually give your money to today is going to do way worse than an index fund, not just somewhat worse due to costs.
The set of active managers actually available at a given moment in time might be 100% long-term losers.
I shouldn’t be surprised, but I can’t help always feeling a bit of surprise when the answer always ends up being “nope, only 10-20% of active managers are beating the market.”
So, if you’re going for actively managed funds, you’ve got a pretty low chance of actually picking a good one.
It’s no wonder index funds have now become the majority.
I have to admit that I don’t know enough about how the financial markets work to know what would happen if 100% of investors went with passive funds. How would that even work? Is that even possible?
http://johncbogle.com/wordpress/wp-content/uploads/2019/08/n...
It’s likely that we need to actually take ownership and not just let everything go as it goes forward.
On the other hand - now we have a situation where most investment savings by individual investors are tracking passive indexes. But if everyone is indexing - what determines the relative weight of each stock in the index?
The answer is active investors. But with an increasingly smaller field of increasingly skilled investors (with more discretionary capital), we end up with the valuations of companies (and thus how societal time is allocated) competitively determined by a fierce prediction competition between the top active managers (Renaissance, DE Shaw, Citadel, etc).
So in the case that say Meta's metaverse initiatives suddenly start taking off with the general population, it will take active investors to invest more in FB to increase FB's marketcap relative to the other stocks in the index so that passive investors are "correctly" allocating to stocks in proportion to their earnings potential.
Obviously there are some caveats here. Passive investors still have to choose an index to invest in, and inflows in to one narrow index (i.e. QQQ) will affect the weights of particular stocks in broader indexes. But the point stands that the relative marketcap ranking between stocks in the index is not affected much by in/outflows in to a particular index, and in some sense indexes are outsourcing their stock picking to active investors that actually try to accurately value individual stocks on an absolute and relative basis.
So they will do things like promote "downside protection", claiming that their returns will be close to Russel 2000, but 90% less likely to go down by 2x more than the Russel 2000 in any year. Which is bullshit because anyone could put 80% of their money in Russel 2000 and 10% in cash and 10% in gold and get the same guarantee without paying anyone for it.
In finance jargon, “cash” is typically taken to mean “cash and cash equivalents,” i.e. money market assets.
In a scenario where passive funds are the best investment vehicle when looking at long term returns, what’s the role of buying and/or trading individual stocks?
Are there cases in which you’d prefer stocks over funds?
I’ve got some Netflix, Microsoft and Apple stock which I plan to keep for the long term. I could never figure out if that money would’ve been better spent as a fund purchase.
What trips me up is stocks tend to lead to bigger earnings (when things go right) and companies like Apple are almost certainly going to remain valuable for a long time.
What am I missing?
Edit: this has been a recurring theme in discussions I’ve had with my dad (who’s a financial advisor, ironically). I’ve pointed out to him that passive funds seem better but he keeps wanting to put my money into stocks, active funds or sometimes narrow, low(er) cost managed funds (e.g. biomedicine and robotics stuff).
Loads of reasons to do so:
1. You might have enough alpha to beat the returns of an index.
2.You prefer a more market neutral strategy and construct your own basket, maintaining it over various timescales.
The fact is that most of these reasons don't apply to your average retail investor though.
1. If you have a view of current market dynamics that you think many other investors have wrong, it can be profitable to go long/short an individual stock. E.g. you have some data suggesting that company XYZ is going to have a great quarter relative to market expectations, and buy some of the stock. Hedge funds do this all the time, with mixed success.
2. Some investors don't want to be exposed to the up/down trends in the overall market, and would prefer an investing strategy whose return/risk profile is independent of the general market. You can do this by creating long/short portfolios in individual sectors/stocks. For example, if you are long stock A, short stock B, you can make money if the market rises or falls, as long as you were right about the relative performance of each stock. In a rising market, you would make money if stock A gained more than stock B. In a falling market, you would make money if stock A lost less than stock B.
Individual stocks are volatile and shouldn’t be used as the bulk of one’s retirement portfolio.
It’s all about risk analysis and mitigation.
Based on what? At the end of the day, that's speculation. Who's to say Apple and other stocks you're holding won't suddenly stop beating the market?
Just to be clear, there are two interpretations (possibly more) of “best” in your question:
* an index fund is “best” if its returns are greater than picking individual investments yourself.
* an index fund is “best” if it is the quickest/cheapest way to balance risk and reward over the long term.
I would guess that the majority of investors in index funds are looking for the quickest/cheapest approach.
If your appetite for risk is greater and you have some time available time to manage things yourself, you can certainly manage your own portfolio.
They're more fun.
> What trips me up is stocks tend to lead to bigger earnings (when things go right)
Cryptocurrency investments also tend to bigger earnings when things go right.
The crux is the WHEN and IF you buy the right stock at the right time AND IF you sell it at the right time. Which most people cannot do consistently, meaning it's more up to luck than skill.
> I’ve pointed out to him that passive funds seem better but he keeps wanting to put my money into stocks, active funds or sometimes narrow, low(er) cost managed funds (e.g. biomedicine and robotics stuff).
Your dad sounds like a horrible financial advisor if that's the investment advice he's giving his customers.
For as long as there have been markets, there are people who think they can beat them. So active management isn't going anywhere and it certainly wont disappear. There will certainly be a time when the active managers win out over passive.
On a related note: I have this particular view that most active managers inside trade. (Look at Steve Cohen, SAC/Point72 - the insider trading was rampant, and I assume that if it was this prevalent and the largest most sophisticated of funds - then its probably pretty pervasive). I think the SEC's continuous crackdown on systematic insider trading is partly responsible for the long decline of active management.
So index funds outperform because their share increases, and their share increases because they outperform. Classic bubble equation.
> Comparison of index funds with index ETFs: In the United States, mutual funds price their assets by their current value every business day, usually at 4:00 p.m. Eastern time, when the New York Stock Exchange closes for the day. [40] Index ETFs, in contrast, are priced during normal trading hours, usually 9:30 a.m. to 4:00 p.m. Eastern time. Index ETFs are also sometimes weighted by revenue rather than market capitalization. [41]
Survivorship bias > Examples > In business, finance, and economics: https://en.wikipedia.org/wiki/Survivorship_bias
Case in point, title says "active managers" ...but if you read the article its actually "actively managed funds".
Which means that before we've started we're already deep into Apples & Oranges comparisons with "index funds" vs "actively managed funds".
"Index funds" are simple, they track an index. (oversimplified, there are technicalities, but we'll leave it at that).
"Actively managed funds" meanwhile have a defined remit, and each fund will have a different remit. They might be limited as to sectors, company size, market technicalities or anything else.
It is also likely the case that there is less interest in "actively managed funds" because if you are in the market for "actively managed" then you may well be constructing your own portfolio of individual equities rather than just buying a fund.
Furthermore, "index funds" can be used by money managers as part of a balanced portfolio. For example, they might pick individual equities in markets/sectors that they are familiar with, and then use index funds for broader geographical or other coverage.
So in essence the Yahoo article is a waste of words and is doing everyone a disservice, including the index funds it seeks to promote.
Most articles are worthless, but it's hard for media outlets to say that nothing meaningful happened in their sector today.