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Is Passive Investment Actively Hurting the Economy?
- prostoalex 11y agoAll excellent points. As a random company moves from being active-investor-owned to passive-index-find-owned, what corporate governance mechanisms are there in place as far as board structure and management compensation? Feels like the management is getting a blank check with no one else being in charge.
- justin66 11y agoIt would be nifty if there were a proxy mechanism whereby index fund shareholders could vote their underlying shares. It's technologically feasible, I have no idea if there are any legal hurdles, or if it's simply something no funds have bothered to implement yet.
- mooreds 11y agoThe issue here is that in order to intelligently vote such shares, passive investors would need to invest time and effort to understand how board members voted, what their interests were, etc. What percentage of passive investors are going to make that kind of effort?
- dilemma 11y agoThe much hated, not much understood, legal obligation for CEOs to always act in the interest of shareholders comes as a result of just the situation you describe. It's called the Principal-Agent problem IIRC.
- twoodfin 11y agoI'm pretty sure Vanguard has a standard "good governance" policy that controls how they vote their shares.
- saryant 11y agoVanguard's proxy voting guidelines: https://about.vanguard.com/vanguard-proxy-voting/voting-guidelines/ https://about.vanguard.com/vanguard-proxy-voting/voting-guid...
- late2part 11y agoThere's a larger context here - the dearth of owner-operators. Perhaps Google and Facebook are exceptions, but the mind-numbing risk avoidance and Wall Street cadence quarterly earnings mentality are not always good.
- eru 11y agoYes, definitely. That's one of the advantages startups can have over incumbents.
- danieltillett 11y agoCapitalism without capitalists, only rent seekers.
- nostrademons 11y agoIt's a self-correcting problem: as more investors place money in passive funds, fewer eyeballs look for opportunities where the consensus price is wrong. That means that there's less competition for these opportunities, which both increases your chances of finding them and increases the returns to finding them. Eventually, active investing becomes fashionable again, because the returns are real and measurably higher, and the cycle repeats. It may be contributing to greater wealth inequality, though: if you look at basically anyone who has become fabulously wealthy in the last couple decades, it's because they saw a profit opportunity that others were unwilling or unable to exploit. The primary form of unwillingness is "It's too risky..."
- foobarqux 11y agoThe fear is that prices won't correct because passive investors are the market. Also, there may not be anyone to take the other side of a trade because passive investors don't trade very often.
- deelowe 11y agoI doubt the avg Joe has that much influence when compared to institutional investors.
- XorNot 11y agoIt's more like HFT which wipes him out. He can't possibly react on the timescales involved, and the market is unlikely to reflect actual business realities compared to the current disposition of several automated financial instruments internal state.
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- JoshTriplett 11y agoIs it just me, or has there been a series of articles specifically putting Vanguard in the crosshairs lately? Between this and the ridiculous attempt to blame Vanguard for being too efficient and charging too little in overhead, I'm starting to wonder if there's a specific campaign going on here. Vanguard is definitely at the forefront of advocating "just put your money in an index fund and wait, don't try to time the market". There's a huge amount of money behind the alternative that will suffer if more people follow that advice. Media campaigns are, on that scale, relatively inexpensive.
- mattangriffel 11y agoYeah, but also this is nothing new. In a recent Planet Money episode (#688: Brilliant vs. Boring), they talk about how when John Bogle first introduced the index mutual fund in 1975, it got a lot of criticism (and not much adoption) with people claiming that they were "un-american" and "Bogle's folly". It's possible that there's some sort of concentrated media push going on here, but the story hasn't changed much in the last 40 years. And I would hope that if people with a lot of money were trying to smear index funds, they'd at least come up with a new angle.
- eveningcoffee 11y ago> It's possible that there's some sort of concentrated media push going on here, but the story hasn't changed much in the last 40 years. My opinion is that if there exists campaign against such investment strategies, then it is possible that this has been going on quite long time already. Like the parent postulated: media campaigns are, on that scale, relatively inexpensive.
- EvanPlaice 11y agoIt's hard to extract value from the economy via short-term pump and dump campaigns when the majority defaults to diversified index funds. Investors with heavy ingluence/ownership of media have a lot of potential to earn from manipulating market volatility.
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- erikpukinskis 11y agoI feel like targeted index funds solve this problem. People make coarser judgements about what "the market" actually means and which markets they actually want to buy into... It's sort of semi-passive. You make decisions on the timescale of financial strategy sessions, which is fine.... You can be an infrequent signal, as long as you are a rational signal you are good for the economy.
- daodedickinson 11y agoI'm glad people are starting to realize that the moral hazard with index funds is far larger than the moral hazard at the core of the last recession. Everyone goes into index funds expecting somebody else to do the homework, so the few quants actually doing homework increasingly figure out how to make money at the expense of the market instead of in a way that boosts the market as a whole.
- saryant 11y agoWhat "homework"? It's an index based on market cap.
- seibelj 11y agoOnce everyone and their grandmother started investing in index funds, I knew it was time to pull out. I do Greenblatt's magic formula [0] strategy now, it's doing pretty well even in this down market. [0] https://en.wikipedia.org/wiki/Magic_formula_investing https://en.wikipedia.org/wiki/Magic_formula_investing
- eru 11y agoYou know, they have index funds that do value investing?
- blacksqr 11y agoIt's the worst possible investing method except for all the others. If anyone could come up with a method that consistently beat passive investing, the situation would change in a heartbeat.
- bunderbunder 11y agoWould it? Or would the discoverer of the method be more inclined to keep the knowledge to themselves in order to maximize their own potential profits? The thing about competitive edges is, if you share them with everyone else then that causes them to disappear.
- blacksqr 11y agoWell, the discoverers of passive investing didn't keep it to themselves, and now they're making lots and lots of money running index mutual funds.
- omegaworks 11y agoSeriously? First you get rid of pensions and force young workers into private retirement funds and now you want to eviscerate the one fund that actually has it in its mission statement not to fleece its members for all that they have. Tell it like it is. The private retirement system was rigged to begin with, with sole purpose to line the big banks' pockets with management overhead uncorrelated to the performance of the funds. Quote Goldman Sachs more. Let's see how seriously your source holds up the next time they orchestrate the collapse of the global economy and come to the taxpayers for handouts.
- AnthonyMouse 11y agoIt seems like funds like this would be relatively predictable in what and when they buy and sell. If they're doing it at a large enough scale and you can predict it ahead of time...
- eru 11y agoPeople already play this game. Enough people to compete away the profits to be made serving the index funds with market making.
- makomk 11y ago> banks whose shares are often packaged in index funds tend to offer higher fees and rates for such services as account maintenance and deposit certificates than banks whose stocks are rarely or never included in index funds Obvious explanation: the banks packaged in index funds are the largest banks. People don't tend to switch banks all that often, so larger banks charge larger fees to take advantage of their existing customers whilst smaller banks offer better deals to get customers. The explanation in the article makes no sense; it's in shareholders' interest that the banks they own shares in make as much money from customers as possible. (Also, since either outcome could be used to justify their conclusion, this is not science.)
- eru 11y agoThe article quotes a scientific paper. Chances are better than even that the paper controls for something as obvious as size. To the articles credit, they linked the study they are talking about. I am still downloading the pdf, so can't say anything concrete yet.
- lingben 11y agohere's a good counter point: http://www.pragcap.com/passive-investing-isnt-hurting-the-economy/ http://www.pragcap.com/passive-investing-isnt-hurting-the-ec...
- ftwynn 11y agoI'm sure there are some legitimate points to be made on this front (indexing methods and such), but this piece reads to me like a giant justification for active brokers and their fees. > But perhaps we shouldn’t be shocked if an investment method that encourages us to use as little discernment as possible ends up being too good to be true. ... are we just not going to mention that no one beats the market forever, so the intentionally simple, though counter-intuitive, decision might be the right one?
- gersh 11y agoAccording to the author, the passive investors are buying into indexes regardless of valuation. However, we know the private unicorns have gotten higher valuations than public companies, which is the opposite of what we'd expect. Further, real estate prices have been going up, and real estate is not a passive investment.
- walshemj 11y agois there not an ETF that is index on property companies ?
- kasey_junk 11y agoLook into REITs.
- gersh 11y agoYes, but how much of real estate is owned by REIT?
- maerF0x0 11y agoThis author shows little knowledge of how the stock market actually works: > A market with more passive investors than active ones will continue to push money into the largest firms, whether these companies are actually performing strongly or not. When I buy an index fund holding the S&P 500, none of those businesses get my money, My money does not go into any of them. I have bought an already existing asset from another person who is selling it.
- finance-geek 11y agoAt a primary level, you are correct. But the effects of passive investment are more subtle. 1. More investment dollars chasing big companies allows those companies to issue more stock without having to worry about pushing prices down (since there is this extra upward pressure of increased flow.) 2. Increased stock prices from increased flow gives the company more stock value for acquisitions 3. If money keeps flowing into particular stocks, it encourages companies to be lax about dividend growth, since the prices rise regardless.
- maerF0x0 11y agoThose are subtle and interesting points.
- watermelon59 11y agoCritics of index investing always overlook the fact that there are many different indexes out there. The criticism always hypothesizes that everyone will put their money in an S&P 500 or a total stock market fund, while the reality is that indexers do all sorts of slicing and dicing with their index funds. By reading just a few posts at the bogleheads.org forum one will quickly see that a ton of people overweight small caps and value stocks (and often the combination of those two factors, small cap value stocks). Some use an S&P 500 index, some use total market. Some hold international indexes (in their different flavors too - developed markets, emerging markets, total intl market, intl value stocks, etc.). Some overweight REITs in their portfolios. The combinations are infinite. I personally believe that even if everyone indexes we'd still see significant activity in the market because not everyone indexes the same way. Also, a lot of indexers like to dedicate a portion of their portfolios to active investing once they reach a certain net worth - I myself plan on doing so. The bottomline is that criticisms of indexing are either made out of ignorance or fear, or they have an ulterior motive behind them (such as promoting a firm's actively managed mutual funds).
- mudil 11y agoEverything has two sides. We are going to see the other side of ETFs one day. And it is not going to be pretty. I read an article in WSJ over last weekend about problems with Blackrock gold ETF that was suspended. Apparently some believe that etfs can get in big troubles one day. They can have either liquidity issues or crash significantly more than their underlying securities. There could be a run. http://www.bloomberg.com/news/articles/2016-03-07/blackrock-resumes-issuing-gold-etf-shares-after-suspension http://www.bloomberg.com/news/articles/2016-03-07/blackrock-... Not first time. This was last year: http://www.barrons.com/articles/the-great-etf-debacle-explained-1441434195 http://www.barrons.com/articles/the-great-etf-debacle-explai...
- yason 11y agoPassive investment probably hurts the economy of active investment business.
- Marazan 11y agoNo
- simo7 11y agoThe argument makes sense. Yet, if so, we should see unreasonably high PEs for big companies (particularly the ones in the Dow). Why isn't that the case?