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Comment by tony69 | Hacker News Reader

Part of the story is how passive index ETFs work. https://www.etf.com/stock/NKLA sort by # shares owned, you'll see the biggest owners of NKLA stock are ishares funds, vanguard etc. These funds buy based on market cap of the stock. Anyone with a retirement account that holds passive etfs (or things like target date retirement funds) is a stockholder in NKLA, a stock which no active fund manager would touch with a 10foot pole.

As passive accounts for more than half of the total market funds/flows, blatant frauds that somehow manage to be included in these funds have an easier time surviving (and the larger the market cap, the more inflows their shares receive). In the 2021 stock mania there were other factors at play too.

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> Anyone with a retirement account that holds passive etfs

This is incorrect. Not all ETFs. These funds are sector focused (vehicles). A regular S&P500 ETF will not hold NKLA.

I was trying to be brief but you are correct. NKLA was not in the SP500, but it was in the Russel 2000. Also, target retirement date funds will hold total stock market index funds, which will contain NKLA.

Look: https://money.cnn.com/quote/shareholders/shareholders.html?s... Top ten holders are Vanguard, Blackrock, & the other usual providers of index ETFs.

Are these ETFs, target date retirement funds, etc. protected against class action lawsuits from shareholders who end up holding the bag due to the inclusion of fraudulent stocks like this? Obviously waivers are signed about how performance is never guaranteed, but that's a bit different from a need to timely exit positions in fraudulent companies.

The whole point of passive investing is to not pick winners and losers, to leave that part of the job to professional speculators (including, yes, short sellers). Because you aren't going to do any better than them on average, even if they do on occasion pick some duds (like Nikola).

Imagine you invested in the index minus Nikola. This isn't improbable as several hours of due diligence would have raised concerns.

This shows that the choice of stocks included in an index is not arbitrary. You don't get "better on average" automatically just by buying the 500 stocks on a list someone sold to you.

The share of Nikola in a total-market index fund was so tiny as to be negligble. If one person invested $100K in a total market fund, and another put together thier own "total market minus nikola" fund, even with zero trading fees, the latter might be up maybe $10 or so over the former. After fees and slippage, they're almost certainly behind.

Sure, but I'm talking about when the professionals that you leave it to end up being negligent. Picking a dud occasionally isn't negligent, but I'm wondering if continuing to hold something fraudulent longer than reasonably necessary to ingest damning evidence and dump it might be.

This might be the case if you paid a professional manager to actively manage a portfolio - but not when you are paying the manager to track an index.

This is quite fascinating. I hope you are able to provide more details on the machinations of these funds. I see the largest allocation is "Direxion Moonshot Innovators ETF" [1], [2].

What money is flowing into this? Why is "Direxion Moonshot Innovators ETF" owned by anyone?

For moments like this, I suspect this fund will liquidate its position? But I'm sure the market for NKLA shares is not that hot...

[1] https://www.etf.com/stock/NKLA [2] https://www.direxion.com/product/moonshot-innovators-etf

>>These funds buy based on market cap of the stock.

> I hope you are able to provide more details on the machinations of these funds.

there are no machinations, it's mechanical, it's betting on expected value while diversifying risk/standard deviation.

Nope - even boring S&P 500 index funds have analysis at their heart. That qualifies those stocks for the S&P 500.

Daily rebalancing is mechanical, and the criteria is coarse- but a decision was made and analysis is done.

And the fund managers do have some small discretion to deviate from the index they track

There is no analysis done to be included in the S&P500. It's 100% rules based. It's extremely unlikely that a stock like NKLA would ever qualify for the S&P500 but it was included in the Russel 2000 (also rules based), and by definition in any total stock market index fund.

Seeing if they follow the rules IS analysis. As is the work of coming up with the rules based on some dataset, which S&P did and does.

Or do you think they yolo’d that criteria out in a vacuum?

It just isn’t micromanaging type analysis. Rather a ‘we think this chunk is worthwhile’ type analysis.

Sure, but in the context of stocks “analysis” typically refers to “fundamental analysis” which means some sort of deep dive into the business model and financial statements of the company… the rules of the S&P are more like “it the market cap above X” and “did it make a profit in the last year”. This is by design as far away from discretionary/traditional “fundamental analysis” as can be.

The caps are set so that the right number of companies fit. Hence ‘500’ in this case. And change to ensure it all works with their goals.

There are many different types of strategies that you’re talking about - momentum, ‘value’, etc. that all set various rules, and are applied in similar ways too.

The analysis I’m talking about isn’t that different, and is still analysis based on fundamentals. It’s just used a bit differently and intentionally trying to be coarse and relatively transparent/mechanical. Private funds keep it opaque and ‘secret sauce’, and have the freedom to do whatever (within the limits of their charter).

Other indexes have more in depth rules that cover exactly the other elements you’re discussing (sector specific indexes, ‘green’ indexes, ‘good governance’ indexes, etc.).

They still use the same analysis tools though.

>These funds buy based on market cap of the stock.

There might potentially be a problem if ETFs owned the entire market, but owning half the market cap still allows for market pricing of the other half. I don't see that you are pointing out a problem?

The market put a price on NKLA, and you are simply claiming that you know better than the market (to hell with the wisdom of crowds); such beliefs are generally unfounded. One example does not tell a convincing story, do you have a portfolio of disbelief that you have tracked the performance of?

You don't need to be at the limit case of 100% of the market owned by passive funds to start creating problems [1].

Still, my point was that passive EFTs create a constant bid on company shares, disregarding any fundamentals. The speculative mania of 2021 artificially inflated the market cap of many SPACs like NKLA - speculators have all the rights to do this, but passive ETFs will blindly follow and increase their allocation based on market cap (the effect goes both ways, as price goes down allocation decreases). Who has been buying NKLA shares? Vanguard, for one: look at fund flows since 2021, mostly positive https://etfdb.com/etf/VTI/#fund-flows most of those inflows result in purchases of NKLA shares.

[1] https://www.acheroninsights.com/blog/wbdvi4uarbd3hdssx3f5kaf...

SPACs are such an obvious joke on the stock system.

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