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The Financial Industry Is Having Its Napster Moment
- williesleg 11y agoNice! Can't wait for fewer mutual fund companies compete for my money! As it is, most brokerages waive the transaction fee when buying or selling a fund, unlike an ETF. Can't wait to see how they innovate next!
- clutchski 11y agoIf index funds become the default investment of choice, will their value diminish?
- Phlarp 11y agoShort answer: yes, and already happening.
- mr_luc 11y agoAs an outsider, I'd love to read more about this.
- rockinghigh 11y agoFees have been going down from 1% to 0.05%.
- cm2187 11y agoBasically if you are following the same publicly known strategy (buy the index), other investors can arbitrage you by buying or selling ahead of you, like before a stock becomes part of the S&P500. That means you always buy stocks dearer and always sell cheaper. That's why confidentiality and anonymity is crucial to a functioning market.
- kdamken 11y agoIf there any difference if people were to instead invest in a Total Market index fund vs a S&P500 one?
- cm2187 11y agoYou dodge the arbitrage of stocks getting in and out of the index but you miss the virtue on using an index, which is that the index rules are not a horrible investment strategy: buy the stocks that are on the rise, sell when stocks are on the way down. But total markets will still have other downsides, like all the stocks become completely correlated if enough people are only making investment decisions on the total market instead of individual stocks, and prices become less meaningful.
- kdamken 11y agoInteresting - I've been saving money and trying to get into investing more recently, and lots of the advice I've read for someone young seems to point towards using an allocation of something like 90% stocks and 10% bonds, maybe like - 55% Vanguard Total Market Index - 35% Vanguard Total Market International Index - 10% mixture of Vanguard bond domestic and international index funds Is there a better strategy out there besides index funds that doesn't involve me getting eaten alive with active fund fees? A lot of what I read suggests that actively managed funds never consistently outperform the market index.
- jldugger 11y agoHurray?
- willholloway 11y agoThe more money that moves in to passive funds, the less efficient the market becomes and the more opportunities for profit through active investment.
- nether 11y agoUntil they reach an equilibrium where active and passive management yield the same risk-adjusted returns.
- AndyMcConachie 11y agoProve it. Where there is a buck to be made, someone will make it. All this talk of index funds ruining capitalism just sounds like a bunch of whiny fund managers not getting their cut.
- optimusclimb 11y agoI don't know about proving that the market will be "less efficient", as OP put it, but certainly the rules would be quite different. If 100% of retail investors were in "passively" managed funds, wouldn't that just be saying there's a giant fund of money available, to be split among public companies that meet certain criteria - and thus a set of concrete rules to be gamed? It would just be another input into the market equation. Investors could then say, "I think the macro environment right now is going to lead to events X and Y happening, which will in turn ruin these 5 companies, which will cause a rebalance in the giant pool of passively managed fund money, and so I'm going to make this bet that that happens."
- elihu 11y agoMaybe the active funds will reduce their fees to stay competitive.
- willholloway 11y agoThe profits will mostly go to algo shops I imagine.
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- wodenokoto 11y agoI read that it is fairly easy to guess which companies will move in and out of S&P 500 and similar indexes, and since a larger and larger part of the market now sits in passive funds it is easy to predict large movements in buy and sell around when these indexes are updated. So that should definitely open up some opportunities to beat the passive funds.
- jgalt212 11y agothese index add/remove trades have been happening for as long as "program trading" now HFT has been a thing. It's a significant subplot of the book, Ugly Americans https://en.wikipedia.org/wiki/Ugly_Americans:_The_True_Story_of_the_Ivy_League_Cowboys_Who_Raided_the_Asian_Markets_for_Millions https://en.wikipedia.org/wiki/Ugly_Americans:_The_True_Story...
- HappyTypist 11y agoNot really, the big index fund providers are smart and they even pre emptively buy companies likely to be added to the index, and they sometimes wait a bit before rebalancing to their index. This intentional randomness makes it very difficult to front run index funds.
- SilasX 11y agoIsn't that, itself, a species of active management?
- arielweisberg 11y agoIt could be construed as such. Really it's all about execution strategy. If your concern is that it's active you can always check to see how well the fund tracks the index. The reality is that they track the indexes so well that it doesn't matter. At least for total market or S&P 500 funds. There are problematic indexes that don't seem to get tracked well by funds.
- beejiu 11y agoIf there was any opportunity to take advantage of large movements, it is likely somebody else is already doing it.
- chollida1 11y agoI kind of get the sense that perhaps some people are upvoting this article because of the title and they just agree with the sentiment. Which is fine but I don't really think this article is saying anything new here. Actively managed mutual funds are going away fast and that's to everyone's benefit. Some were charging 2% yearly plus a fee when you bought or when you sold( redemption fees). I can't think of a single reason that anyone should have any money in an actively managed mutual fund. If there is a continuum of hedge funds to ETF's, actively managed mutual funds are literary the worst of both worlds. High fees and low ability to make returns. From where I sit, the biggest jobs that are in danger are sales jobs. There used to be teams of people at mutual fund companies whose sole job was to sell their products to Investment advisers at brokerages with the hopes that the advisor would put their clients money into these funds. As someone who is on the side of actively managing money, I see this as a strong positive. The more passive money there is sloshing around the more arb opportunities there are!
- vchynarov 11y agoGenerally I agree with you. However I can provide a personal counter-example. I am a student with a modest sum saved away (with great help from my parents) in an index tracking mutual fund. Due to the way my bank offers investment packages, I am far below the minimum portfolio balance required for significantly less fees. However, I can have a mutual fund in a different type of account offering which is essentially the same as an identical ETF. This is (Canadian) RBC - Direct Investing. In addition this particular fund also significantly outperformed other ETFs during 2008-09.
- aianus 11y agoQuestrade in Canada lets you buy ETFs for free, as little as one share at a time. You only pay when you sell ($0.01 a share, minimum $5 a trade). Anything sold by the big banks in Canada is almost always a ridiculous rip-off. Even better might be something like Wealthsimple. (Not affiliated with either company except as a customer)
- mabbo 11y ago
- api 11y agoThey deserve it quite a bit more than the music industry ever did.
- alistproducer2 11y agoThe actively managed funds in my 401k are all underperforming the market. Why pat a premium to lose money?
- hibikir 11y agoThe 401k situation especially egregious: Even good companies in the financial business end up picking horrible choices for their 401k options. For instance, my current employer has an SP500 index fund in their choices... with a 0.3% fee! For comparison, Vanguard charges me 0.05% for tracking the same index, for an enormous, nonsensical profit of the fund my employer picked. And that's the cheapest one by far! Most options are active funds with 2% fees. Nobody in their right mind would use funds like that if they bought them for their own IRA, but 401Ks create a captive audience, so this terrible funds exist, just to abuse companies that aren't paying attention, or are getting something in return of letting employee money get siphoned off. So sometimes, you are paying a big premium no matter what you do.
- kasey_junk 11y agoIts worse than that even, my company has a Vanguard fund that I pay 0.05% in my IRA, but the 401k provider charges 0.3% and pockets the difference! Frequently, the people making 401k provider decisions (HR) are not well versed in finance or the incentives are misaligned (companies are looking for cheap vs good for their employees). This is a situation that congress could easily fix, get rid of 401k plans that are attached to employers, and instead have employers contribute directly into employee IRAs.
- maxxxxx 11y agoI still haven't found anyone who could explain to me why there are 401k plans. Wouldn't it be much easier if people could contribute the same amount to an IRA where they can invest as they see fit? Why should the employer be able to pick available investment options for employees? To me this looks like a subsidy to the financial industry.
- JoeAltmaier 11y ago
- brownbat 11y agoDiversification is good for individual investors, but it's also a good way for an economy, or for a financial sector to hedge against systemic risks. So if ETFs are taking over, it may be an improvement overall, but it's worth thinking through the black swans, the new low probability high impact risks that this creates. Bloomberg has had a few comments about liquidity risks for ETFs on their site and in the Odd Lots podcast.[0] On the other hand, they've made these comments for a few years now, so maybe this is a chicken little story. Or maybe it only kicks in under certain conditions, like if we saw interest rates, demand for goods, and inflation spike, people start moving to other investments, potentially causing a sudden run on funds that are stuck holding only bonds without any real returns or way to offload them? [0] http://www.bloomberg.com/news/articles/2014-09-23/etf-liquidity-risk-a-concern-for-regulators-wilkins http://www.bloomberg.com/news/articles/2014-09-23/etf-liquid...
- x5n1 11y agoSo invest in a black swan fund.
- kuzmin 11y agothis is not how science works
- brownbat 11y agoBlack swan funds have been doing neat things. But I didn't mean to imply I'm concerned about this as an individual investor. I'm honestly not that concerned about it at all, because it seems like an unlikely problem. But to whatever extent I am, the question wouldn't be "how do I protect my own investments?" It would be, "how should we protect all the retirement savings across the country that are placed under passive management automatically?" To really answer that question though, we'd probably have to know the actual level of risk and the timing of any crisis, which aren't trivial questions.
- wrong_variable 11y agoI wonder what will happen to London. Maybe the housing bubble will finally burst ?
- TheOtherHobbes 11y agoAlready happening at the top end. The smart money is talking about moving elsewhere, especially after the recent tax changes. The top end - flats worth a million and up - has a long way to fall, because there's a glut of new build coming onto the market. The mid and lower ends have a lot more latent demand, but the end of cheap buy-to-let will force at least some landlords to sell up. Prices would usually level off, but if sterling keeps drifting lower foreign money will dump a lot of its speculative holdings. That could crash prices by big numbers, and also drop rents because many speculative buys are currently left empty.
- JunkDNA 11y agoDidn't the Napster moment happen in the late 1970's when John Bogle started Vanguard?
- te0x 11y agoNo, in context "Napster moment" is used to describe the effect on the industry, especially when the revenues are moving. Even though Vanguard and ETFs have been around, no one paid attention to them for decades.
- elihu 11y agoI wonder if there's an opportunity for someone to come along and undercut the passively managed ETFs and index funds? 0.10% is still a lot of money when you're managing billions or trillions; is there any reason someone couldn't come along and provide the same service for a 0.01% or 0.001% fee?
- stouset 11y agoThis seems implausible. A 0.01% fee on a $1bn fund equates to $100,000. This isn't enough to pay a single full-time employee, not to mention to actually conduct trades, perform accounting, and deal with legal/tax considerations.
- d4rkph1b3r 11y agoYou don't really need to make any more then that if you're front running your own trades!
- kasey_junk 11y agoDescribe precisely how that works please.
- klipt 11y agoVanguard is the "credit union" of index funds - it's owned by the funds themselves rather than making a profit for some third party. Vanguard has lowered their fees on several occasions as their funds got bigger, and they manage a ridiculous amount of money, so I imagine they'd be very hard to undercut.
- dantiberian 11y agoMatt Levine has a great article on this, exploring the subject with a lot more nuance http://www.bloombergview.com/articles/2016-04-07/fiduciaries-reporters-and-inversions http://www.bloombergview.com/articles/2016-04-07/fiduciaries... (as always).
- ttcbj 11y agoThanks for that link, really helpful.
- minikites 11y agoSince learning about the concept of the Baltimore Stockbroker, I'm thinking that actively managed funds as a concept are horseshit. http://www.theguardian.com/books/2014/jun/13/how-not-to-be-wrong-hidden-maths-jordan-ellenberg-review http://www.theguardian.com/books/2014/jun/13/how-not-to-be-w... >Here's a cautionary tale. A broker sends you 10 free stockmarket predictions in a row that all come true, and then asks for money for an 11th. The stockbroker's offer seems reasonable enough. His strike rate is 10 out of 10, so surely he will be right the next time, too? Don't do it! If you pay for the 11th tip, you will have fallen victim to the oldest scam in the book. Unknown to you, the stockbroker has been sending every combination of possible predictions to tens of thousands of other people, and you are one of the unlucky few who got 10 good ones in a row. >Imagine you are considering investing in a mutual fund. Before funds are opened up to the public, they are often monitored in-house. Funds that don't perform well can be shut down, without the public ever knowing. Ellenberg warns that if you are seduced by funds with an eye-popping rate of return, then you are walking into the Baltimore stockbroker's trap: "You've been swayed by the impressive results, but you don't know how many chances the broker had to get those results."
- tma-1 11y agoI am not very cheerful about the markets being "-largely driven by passive investors. Traditional investors play a pivotal role in corporate governance and strategy, and reward management with a track record. Unfortunately the flows are becoming more and more driven by passive strategies, and this can potentially lead to negative externalities in the economy [1]. [1] http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2663398 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2663398
- PierreRochard 11y agoArticle you linked to is about passive investing in commodities pushing commodities prices up. I agree this is a negative externality. But we're discussing passive investing in equities pushing equities prices up, which have positive externalities in the economy. This is good.
- jeremyt 11y agoI don't think that you have any reason to worry. Once everybody is using index funds, there will be plenty of opportunities for actively managed profits, and people will begin to take advantage of it again.
- seansmccullough 11y agoI think you're right, if a large portion of a company's stock is owned by passive funds, there should be some arbitrage opportunities since the funds won't buy or sell based on the company's fundamentals.
- deleted 11y ago[deleted]
- bluejellybean 11y agoHonestly, I'm with you on this. Still stacking up on index but everyone will have to switch at some point.
- tryitnow 11y agoI too am worried, but if this crisis comes to pass I will do my duty and start working for a hedge fund.
- optimusclimb 11y agoWhy are actively managed funds paid via fees, and not based on performance? If someone (or some company) is claiming to be better than me at using my money to make money, surely they'd agree to put skin in the game, and only profit when I do? If they don't feel confident enough about their choices making money (and hence, ensuring they get compensated), why should I? edit: I was referring to the types of funds typical retail investors are in, not hedge funds.
- gnaritas 11y agoThey do both, 2 and 20 is standard, 2% fee yearly and 20% of the profits they make.
- kasey_junk 11y agoThat's true of hedge funds not mutual funds. The op was imprecise.
- optimusclimb 11y ago> The op was imprecise. True. Edited my comment.
- jzwinck 11y ago> If someone (or some company) is claiming to be better than me at using my money to make money, surely they'd agree to put skin in the game, and only profit when I do? Imagine you believe that mail order companies are poised for rapid growth in coming years. You don't know which ones specifically, and there are thousands. So you buy a mutual fund which holds hundreds of these companies. This gives you some diversification and lets you make your bet with only a single commission to buy and sell. But the fund manager may disagree with your investment thesis. She may be fully convinced that online shopping has already destroyed the mail order business permanently. She would therefore gladly run a fund for you, but she would not bet on its performance herself. For a somewhat more real-life example of this, watch or read "The Big Short." The protagonist wants to buy something that the banks think will lose money.
- jeffdavis 11y agoIs there really such thing as a passive fund? I have a strong feeling that the contents of the index (or at least weights) can still be manipulated. And also that the fees are just moving down the food chain somehow. If you think I'm wrong, just consider that a public company can own stock in another public company. This will all become more obvious when "passive funds" take over more of the market.
- DINKDINK 11y ago>Is there really such thing as a passive fund? To me passive and active are ends of a spectrum which specify how much labor and trading is done with the fund's assets.
- kasey_junk 11y agoI'm not sure I understand what you mean. "Passive" is descriptive of the strategy & nothing more. Those funds are trying to mimic the returns of a particular market segment. If a passive fund argued that a particular market segment had implicit fees & therefore they charged similar, it would still be passive.
- jeffdavis 11y agoThe article is talking more about the declining average load due to passive funds. If the average load goes down, I'm saying that those fees are probably just moving somewhere else rather than upsetting the industry.
- nostrademons 11y agoIt moves into the price discovery mechanism of the market. More people in passive funds => fewer people doing active research on companies => greater likelihood that the market price of a security doesn't reflect the underlying fundamentals of the business => arbitrage opportunities for active traders, as chollida1 pointed out. People will still get phenomenally rich in the stock market, wealth inequality will still increase. The difference is that people have to work for it now, building up their own information advantage, rather than being able to siphon off large fees simply because they went to a good school and talked a fellow alum into hiring them. This is a plus in my book.
- p4wnc6 11y agoI think this is pretty naive. Customers (generally large institutional investors) don't choose active managers because those managers provide superior returns. They choose them for the same reason that people choose big consulting firms like BCG or McKinsey: status and affiliation, nepotism, internal power struggles, and cover-your-ass blame insurance. I mentioned in a previous thread about this -- I worked for several years in an asset management firm before moving on to other things. We frequently assisted clients in the process of firing us. We would prepare white papers for them, give them data and slick charts. Sometimes this would literally disrupt the quants and research team and we had to join in creating materials that would be used by client board members in their presentation of the decision to fire us. Sometimes we even had to provide examples of this kind of work when a client was hiring us -- our helpfulness and data services during the times when we are fired was actually a prominent selling point. We were basically saying, hire us now and you get to look fancy. Fire us later and we'll set you up to look principled and full of conviction to do the right thing as a sophisticated board member. There are all kinds of laws restricting gifts you can give to clients or receive from clients, and just as many stories about how such-and-such a client took some regional sales manager out to a strip club, or flew them some place and got them a reservation at some exclusive restaurant or something. It's all political. As a technical person, you are hired to look fancy on paper. I remember overhearing my boss bragging to a prospective client that the team had an "Ivy League graduate" leading up their quantitative software development ... on my second day of work! I had zero financial experience of any kind at the time. It was ludicrous. It's painful to see everyone buying into this. I hope beyond all hope that clients do a better job of actually holding firms responsible for returns. Firms that don't engage in legitimate statistical research to determine an edge in investing will fold up, and firms that actually have a chance at superior returns might actually start letting their staff do real research work instead of bullshit marketing and catering to client political whims. But that's a fairy tale world. This will all blow over and clients will continue dedicating huge blocks of their endowments or retirement funds to active managers for political reasons and will continue happily not holding those managers accountable for inferior returns.
- MakeUsersWant 11y ago> They choose them for the same reason that people choose big consulting firms like BCG or McKinsey: status and affiliation, nepotism, internal power struggles, and cover-your-ass blame insurance. There must be some lean way to exploit that. In theory, you could manufacture status for your consulting firm. (So that's why BCG and McKinsey plaster German universities with their ads.)
- jheriko 11y agotl;dr: the financial industry is distasteful. i understand what is being said here. i don't think it is revelatory. on the other hand this article just adds another small contribution to my strong distaste for the practices of the financial industry overall. investing money into funds to make more money seems great at first glance, but once you dig into the details and realise the number of people involved taking their cut, how many companies are effectively running off of weird loans through 'ownership', and how many piles of assets are owned by people as a mechanism to make more money... its all very distasteful to me. :( then again, i don't like investment. i don't want it for my own company. it looks like a way to become beholden to others and introduce a risk of spending more money than you actually have.
- chvid 11y agoThe financial industry (as a whole) is very very far from having its Napster moment. The industry has gotten much tighter regulated since the GFC giving the incumbents an even stronger grip on their position. And the specific low-cost index funds, the article is dealing with, have been around for decades now. I really don't think the headline is called for.
- erikb 11y agoSorry but what's the difference between ETFs and index funds? It was presented to me as the same thing just one word being more common in Europe and the other more common in the US.
- morgante 11y agoETFs are exchange traded funds are just that: investment funds which trade on an exchange, where you can invest and divest by trading a symbol. Index funds are investment funds which seek to match the performance of a target index. The concepts are orthogonal. You can have index funds which aren't ETFs and you can have ETFs which aren't index funds.
- erikb 11y agoQuite interesting, thanks.
- known 11y ago"Give me control of a nation's money supply, and I care not who makes its laws." --Rothschild since 1744
- atemerev 11y agoAs a member of financial industry, I wouldn't say that. "Active" brokerages are biting the dust? Well, good riddance! Moving people out of the loop is generally a good idea. Now, passively managed funds are a good thing, during the growth market. However, once around every ten years, a recession comes. Then, suddenly, index-tracking funds become passé, and everyone wants a strategy to survive the market downfall. And we have a lot of things to bring in from the current tech state of the art. Blockchain is ingenious, and the art of defining modern financial instruments using blockchain features is in its infancy. So, there is a lot of work to do, and lot of potential to grow.
- arca_vorago 11y agoWhats really happening is the the really big players are now extracting wealth from the middle ones. For the American people, this means the middle class gets destroyed, but the key here is that lots of people that are technically "middle class", are really in the top lowerhalf of the 1%, but many of them don't realize the wave to come. So once even the 200k/year lawyer down the street is suddenly homeless because he actually had negative net worth, then it will be too late, but the real point is that there is no more money to be extracted from the lower classes except by death by a thousand cuts (taxes), so all the middle men hedge funders etc are going to be mergered and acquisitioned away as the banks learn how to manipulate the blockchain market and take it over just like they have everthing else. Digitalization of the financial industry is just the buzzword scapegoat they are going to use to get it done. The same way in which, you see the former director of NSA leaving and joining a bank, and then yelling doom and gloom about hackers zeroing out accounts. All that tells me is that is what they have already planned. I can see the headline now: "Hacker breach $BANKS, transfer $BILLIONS. Another bailout unavoidable to prevent collapse." I've said it before, and I'll say it again, the elite oligarchical international bankers are closer to terrorists than businessmen.