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Comment by wing-_-nuts | Hacker News Reader

>what happens in a theoretical market where 100% of investors were in an index funds?

That would never happen, because the more a market tilts towards index investing, the larger the incentive and opportunity that active management has to exploit misspriced assets. The trick is that the very act of exploiting that opportunity updates the price and eliminates it long term, and the harder it becomes for active investors to find misspriced assets.

TLDR: Active managment effectively performs a service to the market, and gets rewarded for it, but the reward is small and fleeting

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I wonder if we reach a point where the concept of "mispriced" stops really making sense?

Because when you say a stock is undervalued, isn't what you're really saying is that you think it's value with increase at a higher rate than the rest of the index in future, because it will attract above-average rates of investment from other active investors? Or to put it another way, "in the future more people will want to buy this stock than other stocks, so its value will go up".

But if everyone else is the market is investing passively, where does disproportionate future demand come from?

I think maybe you should go back to first principles.

Why does a share of a company have any value? Well, if you buy 10% of the stock of widget co, you presumably get 10% of it's earnings, be that through dividends, share buy backs, etc. It's stock price will reflect that. It also reflects the future potential growth.

For some companies, (utilities, etc) there isn't much future growth so the price is mostly a function of it's ability to pay out dividends. For a tech startup, they're not paying out dividends any time soon and the price reflects it's potential to someday be BigCo with massive earnings and massive dividends.

There will always be active investors trying to beat the market, and they aid in price discovery.

So you think that active investors would shift much more towards trying to make money from dividends, rather than from speculation on the future share price?

No, I think active investors make money from trying to find over/under priced equities, and the value of those stocks is inherently a function of current and future returns.

So is your thesis that active investors will actually start to perform better as index investing continues to rise further? I believe over 50% of it is now passive.

The potential rewards to active investors are higher, but the very act of exploiting those opportunities exhausts them. As always, 10% of traders will beat the market, even net fees. The rest will continue to underperform the index, and importantly, the cadre of 10% traders changes from year to year and decade to decade and there's really no predicting it.

It's always interesting to read the frustrations of star fund managers and how difficult it becomes to sustain success just as they get popular.

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