Everytime one of these articles comes up, someone says, "but who will do price discovery, this is terrible"
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?
> Everytime one of these articles comes up, someone says, "but who will do price discovery, this is terrible"
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]
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.
This isn't taking into account that there is really no such thing as 'passive'. In reality, passive investors are constantly either investing with their paycheck, or selling in retirement. They are the world's simplest active investors. If you put money into passive then the index buys. If you request money, the index sells.
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.
That’s an interesting way of looking at it, but it seems incomplete because for every buyer, there is a seller. A paycheck isn’t converted into stock, it’s traded for it, so some other account gets the cash. Supply and demand meant that asset prices went up, but that meant that the sellers got more cash for less stock.
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.
> This isn't taking into account that there is really no such thing as 'passive'. In reality, passive investors are constantly either investing with their paycheck, or selling in retirement. They are the world's simplest active investors. If you put money into passive then the index buys. If you request money, the index sells.
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].
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]
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.
I think grandparent has a point - passive is a misnomer. Academic analyses of passive investing start right after the securities have been acquired and before they’re sold, which pretends that passive flows have no effect on the market (by definition - « always holding exactly 3% » implies no selling or buying, otherwise it is not possible)
« 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!
That's a passive failure mode I haven't seen before. To elaborate on what you said:
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.
Index fund managers aren't idiots. Their trading systems still have a degree of sanity checking and human oversight, so they won't attempt to track the index exactly if things get weird. But for large-cap indexes like S&P 500, the "diamond-hands hodlers" lack the capital reserves necessary to really manipulate the market. At some point many of the underlying companies would also take advantage of excessive stock prices by issuing secondary offerings, thus increasing the supply.
You're leaving out three factors: indexes are not static over long terms; the creation/destruction of new public corporations; and the possibility of existing public corporations offering more stock.
There's two key ways new stock can be created to avoid this risk: companies can issue it, or short sellers can create it. If the company sees its stock rising, it can and should see that as a cheap source of capital and absorb some of it through a stock sale to do more of whatever business they're in.
You think that companies are going to issue new stock in order to ensure that the value of their company doesn't go UP? If anything, the more they take out loans and buyback their stock, the faster it goes to infinity. And the faster it goes to infinity, the more collateral it has, to take out another loan, to buy more stock...
And you think short-sellers are going to risk infinite losses? This is a prisoner's dilemma that you aren't going to win.
> If the company sees its stock rising, it can and should... absorb some of it through a stock sale
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.
The person they borrowed it from also still owns the original share. The borrow creates a share, and the repayment destroys it.
Fractional reserve stockholding.
Yeah, I knew about that. I had to look up their relative size to mutual funds though. Turns out mutual funds manage $23.9T compared to $5.4T in ETFs. I guess passive funds are more likely to be ETFs. But it could mean there is enough passive mutual fund money to pose a problem.
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.
> What's the argument that active managers aren't just rent seeking parasites lying about their roles?
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.
If markets stop being efficient at price discovery, why wouldn't active managers and hedge funds exploit that inefficiency? In other words, why are active managers and their supporters arguing that they aren't good at their job?
(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 everyone invests in the sp500 then the price of the sp500 will climb, guaranteed, because you know that next months paychecks will purchase more of it.
You can’t really do anything about this even if you’re actively aware of this mechanism and think it’s fundamentally over valued.
What isn't a ponzi scheme these days? If you're passively investing in stocks, it's a ponzi because of the reason you outlined. However, if you're actively investing and bought a stock that's a little too popular (eg. tesla), then that's also a ponzi because "the company doesn't make a profit and the way people are making money is from new investors paying older investors". Hell, even if you only buy blue chip stocks with reliable earnings, some of your original complaint is still there (ie. people mindlessly buying it because they know it's reliable, new investors paying old investors).
While the stock market may be stupid, it's not a Ponzi scheme. A Ponzi scheme involves a fraudster lying about where the money is going and coming from, and thus defrauding people.
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.
I cant tell if youre joking or not because I sorta do think it is all a scam. I think the stock market is a way to keep the sociopaths doing something less dangerous than continuous war and insurrection. Whether intentionally or not, I think that's it's primary value.
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
I try and think about it from our tribal, small group primate origin perspective. I hope you're not mocking me, but if you are, I still do think it's interesting actually. :)
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.
> What's the problem with trying to explain human motivations like greed using our evolution?
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 think maybe you're talking about something else, or believe that I am, or I'm misunderstanding you because it feels like you're trying to tell me that my _imagination_ is a parlour trick. Ive been on the internet for a long time and this is the first time that has ever happened.
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.
> my _imagination_ is a parlour trick...there's no trick. It's just a thought
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.
[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.
I notice you left out the 'I think' from when you quoted me. That's how you were supposed to know it's not fiction, it's not a parlor trick, it's a thought. Kinda like brainstorming. Suggesting there is a 'trick' to what I'm writing implies (to me at least) that I'm attempting to deceive. I assure you I am not.
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.
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.
You edited your post to add more detail for some reason. No, it’s still not clever.
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.
I comment in bursts, which has me hit rate limits on HN. Then I have to use edit-functionality till rate-limit-expiry.
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.
There'll never be a shortage of people who think they can beat the market. Market beating is just such a compelling illusion. Also passive funds are not quite 100% passive. What does everyone do when they're broke? Stop investing. How about when times are good? Pile more into investments. There's also many different types of passive funds with slightly different biases. There's world passive funds (which have maybe 40% not in the S&P). There's passive funds that track other specific countries. There's ESG passive funds that avoid oil companies and such. There's passive that skips China. There's investor biases in there and prices being discovered all over.
Now throw in all the other active funds and average them out. Also Berkshire would not have been the better investment over the last decade. Can you guarantee me Berkshire will pull ahead before I retire?
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.
That's incorrect, you forgot the dividends. I went with an analysis from last year where Berkshire was behind and was doing worse than the S&P. Now they're about evens. Berkshire is now an S&P500 tracker.
What a silly thing to stay. Let me just ignore that and explain why Berkshire works. It's possible to beat the market because it's possible to buy $1 for $0.95. That's the whole trick. It takes a lot of work, a lot of smart people, and you have to make big enough deals to cover the cost of paying the managers, but yes, these opportunities exist and they are abundant. The real mistake is thinking that the market is a bunch of random number generators with no rhyme or reason to it. But no, there are no guarantees--the SPY doesn't come with a guarantee either.
That makes no sense at all. What you're saying is it's possible to hire people who can see the future. Index tracking works because the market as a whole generally trends upwards if you wait long enough. This would be expected as the world generally gets richer and technology generally improves. The problem is you can't predict which exact company is going to do the improving. So just buy a very wide spread of companies and take the average. 80% of active managers fail to beat the market because they cannot see the future. The other 20% are lucky (today). If you want a lesson in the dangers of active management, look up Neil Woodford.
You only need to hire people who can see the future from the perspective of the market. It is entirely possible, and it is the reason why insider trading is heavily regulated.
Ben Felix cited in a video that Berkshire's excess returns can be explained by their value tilt, and after accounting for that, this apparent excess return is statistically insignificant.
> but who will do price discovery, this is terrible
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.
You’re not considering that a lot of active managers are helping clients define bespoke investment strategies that suit their assets and liabilities. They set a strategy, pick a benchmark, and invest. In some cases, a portion of those investments may be passive instruments and other portions may be research-driven asset allocation by the manager.
Clients are heard and in charge. These are smart people who will terminate the relationship if their goals aren’t being met. This isn’t your retirement account. These are accounts in the 9+ figure range.
There are actively managed funds that hold stocks, bonds and other instruments and constantly balance those ratio on a daily basis to give investors a steady state of returns (think 4% to 6%). A lot of folks who want fixed income returns instead of cap gains growth purchase these funds. Retirees and pension funds are big consumers of these product.
This requires complex daily work and would be nearly impossible for a financial advisor to perform.
Vanguard targeted retirement funds. VTTHX is their 2035 target fund. They are constantly readjusting their balance of stocks/bond/cash to meet a stable return in the year 2035.
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.
Interest to revisit such militant attitudes should the current crash of inflated bullshit techcos continue.
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.
I don’t understand what point you are trying to make.
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.
You aren’t tracking the whole market. An index is a subset. Even total market indices have weightings which embed biases. And the whole game has been reverse engineered by charlatans to dump crap into rivers of blind money. If think capital offerings aren’t designed explicitly to target index inclusion criteria then you aren’t in on the joke.
> And the whole game has been reverse engineered by charlatans to dump crap into rivers of blind money. If think capital offerings aren’t designed explicitly to target index inclusion criteria then you aren’t in on the joke.
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?
The arguement in both cases is that if someone is doing something useful in a market (like price discovery) they'll be paid according to how useful they are. And if their pay exceeds the cost then they'll profit. If not then your guy (or girl, or other descriptor) isn't useful and you're paying them from your picket. But it's your job to check and move your money accordingly. And you'll be paid for doing so, and penalised for not doing so.
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
Personally, I dont think price discovery is the biggest problem, but no overseight of the board of directors. Etf do not actively vote (as far as i understand). So this opens up for management and minority owners to run the comopany badly (or even plunder it). This is a negative effect in the long run though.
BlackRock absolutely votes. The concern is arguably the _opposite_: in the index model ownership is concentrated in a few large institutions with very broad diversification, which creates some odd incentives.
Matt Levine has a bunch of articles touching on this topic.
But ultimately the indices are incentivized by the underlying companies' growth, as to make their customers happy, thus it is in their best interest to take sane votes?
Well, we've kind of known that the benefits of active management would be diminishingly small. In theory they could be working just as hard, but at this point they are being paid to clip coupons that aren't there.
Price discovery just happens on a different pace mostly around earnings. But you’re still at the mercy of market makers which is a big problem on its own. We also have bonds/convertibles to help price securities.
The market does price discovery if it's not program traded.
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.
William F. Sharpe published the very short (two pages) article "The Arithmetic of Active Management" in 1991:
> 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.
But does it matter that the category of "active managers" achieves near-parity (after costs) with index funds if you're not able to maintain a running bet on the whole pool of active managers (i.e. you have to pick one or more specific managers)?
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’ve been something of a Boglehead for a long time, but every few years or so I try to look up analysis of active funds to try and see if they’re starting to beat the market as a whole.
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?
Bogle himself talks about a bigger danger than price discovery etc - when all companies are owned by index funds effectively nobody owns them - and so they’ll be run by the managers for the managers.
In effect, they are owned by Vanguard, Blackrock, Fidelity, etc. Those firms buy the shares with your money, then those firms pick the boards of the companies they bought with your money. So basically the boards of a hand full of the big investment firms own and run every publicly traded company.
I dont understand why congress doesnt just mandate that voting rights go to the ultimate owner in index funds, no the management firm. Would be a pretty simple fix.
How many retail investors would be prepared to intelligently vote a handful of shares in ten different companies each week? Just digesting all their annual meetings sounds close to a full-time job. If I care a lot more about a handful of companies, I’d probably hold their shares myself.
There's no incentive for Congress to remove power from their donor class. You have to solve that problem first, then you can worry about how the implementation works for the peasants.
It might be the case that we need to consider owning competitors an illegal conflict of interest, as if the whole market is majority owned by passive owners it's not so much a market of competitors as sibling subsidiaries.
my personal theory is that active management can still produce market-beating returns but the good active managers will rapidly grow their capital base to huge levels where they don't need much outside investment.
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).
I guess the big question how much active management is good. According to the article for funds it is now roughly 50%. I believe even 10% is plenty for market efficiency.
I was under the impression the relative weights are (often) simply proportional to their market cap. Afaict that's how that works for the sp500 at least.
Exactly, the relative weights are often proportional to the market cap. So if I invest $1M in the S&P that doesn't actually change the relative weights of the stocks in the index (mostly), since the impact on all of the underlying stock market caps should be roughly even as more money flows in to the stocks with higher market cap and smaller sums flow in to the stocks with lower market cap.
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.
Active managers make way more money selling their fund and increasing deposits than actually beating the market.
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.
All the things I’ve read about passive funds have pointed in the same general direction. I can completely buy the reasoning but I worry I’m missing part of the point, which brings me to my question.
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).
> Are there cases in which you’d prefer stocks over funds?
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.
> 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?
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.
Would you be willing to go into more detail about those two reasons? I feel I don’t have enough experience to understand the reasoning underlying them.
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.
The financial markets are a fantastic ecosystem. There are all types of players out there: short-term vs long-term, high-frequency vs low-frequency, technical chart readers, fundamentals, macro, hedgers, punters, speculators, 401k managers, retirees, r/wsb, retail, institutional.
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.
As someone that once implemented close to 100 different indicators for a real-time stock chart AFAIK there is no evidence that technical analysis is particularly useful. In the short-term markets are lead by sentiment and in the long-term by fundamentals, neither of which are really captured by indicators.
Aside from costs, index funds may have outperformed because their share of the overtall pie has risen. If you consider an index fund to be an asset on its own, the price of that asset rises as more people invest in it. As a result, equities that are underrepresented in indices decrease on average, while those that are overrepresented - increase. We see evidence of this in the fact that equities tend to fall shortly after being removed from key indexes.
So index funds outperform because their share increases, and their share increases because they outperform. Classic bubble equation.
Are there index funds that are similar to hedge funds? I am looking for indices that generate returns that are uncorrelated to general market performance. Because that's what the hedge in hedge funds mean.
Yes and no. There are products that track hedge fund performance [0]. But ultimately these reflect active investment decisions, while a proper index fund does not
This is a macro phenomenon and will stop soon since the central bank has stopped printing money. Since 2008 major Central Banks are actively buying bonds in droves which companies use to buy back their stock and as a result increase prices of their stock. The passive strategy will not work anymore now because companies with high capital costs will get hammered.
> 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]
Its actually a very poorly written article, more clickbait than actually saying anything useful.
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.
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?