11 ms·

As a Vanguard customer, I can understand why people are so enthusiastic about their products, and have known for a while that passive investment, and Vanguard i

As a Vanguard customer, I can understand why people are so enthusiastic about their products, and have known for a while that passive investment, and Vanguard in particular, was growing while active management was on the decline. At no point did I think the difference in inflows was anywhere close to 8.5x. And it does worry me. I'm familiar with the contention that even having some active players in the market will arbitrage the prices back to fair value, but when they compose such a small share of such a large market that's no longer a trustworthy assumption to make. There's no law that I know of that prevents active players from exploiting the knowledge that passive money will go wherever the market tells it to. There have got to be a lot of opportunities here for profiting, legally, at the expense of those passive investors, that goes beyond simple margin arbitrage. My point is, the less active money there is around, the less accurate our concept of a correct value can be. This situation has the potential to de-stabilise the economy sooner rather than later.

bike4beer 10y ago
About ten years ago I sold some real estate and moved some money into a Vangaurd fund it was easy, took a few minutes to setup the account online, and transfer from my credit union to the fund. Done. Five years later I tried to get the money back, I tried online but the website always failed and told me to reset my password. Finally after months I called, after hours of waiting on the phone ( skype ) I was told it was a tech problem, and need to talk to tech. After months of playing tag I finally got past the password and it said that the new password was sent to my mail, but I have to 'login' to read the mail, and they will not send your mail 'internet mail', so now I can't get any communication, and still can't access. Whenever I call its always the same problem, its non-english speaking people, also they only do telephone support a few hours a day, its not 24 hours like say Fidelity. So now its been 10+ years, and I have never been able to make a withdrawl, when I call I always get a run around, there is no Vanguard office where I live, so there is no 'face' to make demands. When I make requests I never get a response. In summary, Vangaurd is a black-hole; Be careful I'm glad in this case its only $10k, I'm sure by the time I ever need the money they'll say it was an abandoned account the money passed to gov, most country's have such laws where an account abandoned say 3+ years the money goes to the general fund. Anybody else here have a similar 'vanguard story to tell'?
solaarphunk 10y ago
ETFs can be arbitraged much more efficiently due to creation/redemption features. There are market markers like Jane Street who do a ton of this. The more risky effect is that all stocks in an index become more correlated with it over time, leading to larger jumps in single names around earnings seasons when real information is released to the public.
- fowl2 10y ago
  well presumably in a market based on fact, changes should be focused around when information becomes available, right?
postozoan 10y ago
Yeah, the slow and steady rise of stock prices across the board is in large part just an effect of increased money supply. Sure, lifting along with that passively is cheap and reliable way to make money. But since these types of passive investments care little about how efficiently the beneficiaries make use of these investments, there's the danger that inefficient companies end up with too much capital. If that happens, you end up with resources such as labor being wasted. The efficient usage of the available resources is of course a much better indicator for the quality of the economy than the rise of stock prices.
- matt_wulfeck 10y ago
  > there's the danger that inefficient companies end up with too much capital I can't see why this is any kind of danger. Companies end up subjectively with "too much capital" all of the time in this market without being part of a large index. Look at tesla.
zip1234 10y ago
I think you have identified that this is a self-correcting problem but are selling yourself short by thinking that the economy will be destabilized. If everyone goes towards passive investments, there will be huge opportunities in active investment because the passive investing is not correctly identifying value. These opportunities are likely to cause an outflow from passive into active if that is where the money is.
- TheCoelacanth 10y ago
  And the market is so huge, that even a slight amount of mis-pricing is a huge opportunity for active investors. A systematic mis-pricing of 0.1% is worth $18 billion dollars. That means the incentive to try to exploit even a minuscule amount of mis-pricing is huge.
  - wdewind 10y ago
    > A systematic mis-pricing of 0.1% is worth $18 billion dollars. Can you expand on what exactly that means?
    - scrooched_moose 10y ago
      I assume they're basing it on the combined market cap of the S&P 500 [1], the most common passive fund championed by Buffett [2]. At a market cap of $18 trillion, .1% would be $18 billion. Although, they may be basing it on old data, as of March 31 it's closer to $21.2 billion 1) http://siblisresearch.com/data/total-market-cap-sp-500/ http://siblisresearch.com/data/total-market-cap-sp-500/ 2) https://www.fool.com/investing/2017/02/26/warren-buffett-just-revealed-the-best-investment-m.aspx https://www.fool.com/investing/2017/02/26/warren-buffett-jus...
      - ethbro 10y ago
        I think the question might have been what a "systemic mispricing of 0.1%" means. If the majority of the market is passively rebalancing, does the true value matter or does the weighting swamp it? I see how one would make money on arbitraging pre- and post-90s mandatory rebalancing by major passives. I'm less clear on how one arbitrages difference between the prices passives are investing at and a "true" price.
lr4444lr 10y ago
If you're a Vanguard customer (buying the flagship fund classes, I presume), you're expressing faith in CAPM[0] and EMH[1] on a significant level. Some active investors will probably in the long term scoop up some extra gains, but the question still remains: which of them, over what time horizon, and is that a risk you want to take? Vanguard gives you lots of no-commission funds with 1 day liquidity even in the mutual funds - plenty of room for you to try and time the market if you think you can have a go at active trading around some predictable flows if too many people are passively investing. Nothing stops you. [0]http://www.investopedia.com/terms/c/capm.asp http://www.investopedia.com/terms/c/capm.asp [1]http://www.investopedia.com/terms/e/efficientmarkethypothesis.asp http://www.investopedia.com/terms/e/efficientmarkethypothesi...
- dsacco 10y ago
  I think the parent commenter is more concerned about the economy's overall stability, and believes passive investors could be exploited due to mis-pricing index fund underlyings. I didn't interpret it as a worry about missing out on active investment, but I could be wrong.
  - headmelted 10y ago
    ^^ Effectively this. My concern is that if everyone is in the passive investing boat then we're no longer following the market, we're making the market, and it's a big departure from the philosophical under-pinnings behind the idea of passive investing. (We started out letting active players make the market by placing good/bad bets and winning/losing. We got a market that was at least trying to find the right price and we did well due to the low expense ratios. Now that we're in the majority, I'm concerned that no-one is trying to find the right price anymore.) tldr; I have mixed feelings about passive investing over the long term if we're no longer small fish in a big ocean.
    - pitt1980 10y ago
      what's a good hedge against this?
    - 10y ago
tryitnow 10y ago
It's been a looong time since I've studied financial economics but I do think there's an active research literature around this topic (under the topic of market microstructure maybe?). If I recall correctly (and again, it's been a while), I think the amount of passive funds has to be quite substantial for markets to be really bad at reflecting value over the long run.
- L_Rahman 10y ago
  And it's a recurring topic in Matt Levine's Money Stuff newsletter. The finance community is not only aware but actively thinking about the ramifications of the situation.
kolbe 10y ago
> the less active money there is around, the less accurate our concept of a correct value can be The problem is deeper than that. Active shareholders actually give a shit about corporate governance. Collectively, they put honorable and competent people on the board of directors, and make sensible decisions when other issues are put to shareholder votes. Vanguard and other indexing funds could barely care. Their incentive to care is so small, we may as well call it nothing. Whereas the employees who control these voting blocks at Vanguard can easily make decisions that cause 10,000x more financial impact than their total compensation. And whenever someone is endowed with such power, human behavior throughout our existence has shown most people will be corrupted by it (e.g. see government employees).
- marcosdumay 10y ago
  Yet, this is a general problem of all kinds of investment funds, not only of index ones. It is a huge problem (and probably responsible for much of the lawlessness we can find on Wall Street), but the switch from active to passive investment shouldn't change a thing.
  - kolbe 10y ago
    It's not necessarily active vs passive. It's skin in the game vs no skin. Low fee index funds offer no incentive for the managers to do any actual managing. They follow an equation, and collect a few bps.
    - marcosdumay 10y ago
      Yes, it's not even that simple. It's about having enough skin on the game. No big fund manager has enough skin on the game. That has been true for most of last century and all of the current one, and the expected results are visibly there.
      - kolbe 10y ago
        This is why my push isn't to necessarily increase the active management profession, but instead increase the intelligence of individuals and freedom of necessary information for them to properly manage and understand their own assets. Even if they do just end up choosing to invest in a market cap weighted broad based index, it's important for them to understand how to behave with the management of those assets and to have the ability to manage them (see the distinction versus investing in index funds, because Vanguard's investors do not manage their assets). And if they do not have the requisite intelligence to manage and understand the things they own, maybe they shouldn't own them.
danmaz74 10y ago
> This situation has the potential to de-stabilise the economy sooner rather than later. If these passive investment funds create a positive feedback loop for some stock prices - I don't know if that's the case - then this could be a pretty high risk. On the other hand, I would intuitively expect them to have a dampening effect on the "pump and dump" schemes that created so many bubbles. So, in a way, they could even help stabilizing the markets?
pdog 10y ago
Active money is trading much faster these days. A smaller percentage is enough to make the market efficient. The outflow is mostly from active domestic equity mutual funds (average expense ratio: 1%-1.5%) to index domestic equity ETFs (average expense ratio: 0.1%-0.2%), so it's really about lower costs and the relative underperformance of active management.
reddytowns 10y ago
If most people ends up investing in strictly index funds, it would end up badly foe them but I don't see it by itself causing a destabilization. Just a lot of people making sub market profits. It would take a large amount of people doing fad based investing and switching all at once cause destabilization, such as what happened during the dot com bubble and the housing bubble. If investing decisions get slower in general, then I think it would be a good thing. The number of company decisions made only for only the next quarter rather than long term profitability would be much less if it took time for people to switch the companies they invest in rather than doing so instantly, which would in turn make a more efficient and stable market.
fictioncircle 10y ago
> My point is, the less active money there is around, the less accurate our concept of a correct value can be. This situation has the potential to de-stabilise the economy sooner rather than later. That won't happen (probably). The less accurate our concept of correct value is, the more competition it will draw as the margins increase. Realistically, we can be probably something absurd like 80% passive funds and 20% active investors and be fine.
yborg 10y ago
>such a small share of such a large market I think you underestimate the size of the active players in the market, especially considering leverage, which they generally are to the hilt.
bluGill 10y ago
Vanguard is not as passive as you think. they don't trade often, but they do trade. Their S&P500 fund doesn't just hold stocks in the S&P500, it also holds other stocks that could have been but S&P500 had S&P not limited the index to 500 stocks. Vanguard fund managers regularly make active decisions on what stocks to buy/sell. Vanguard is not nearly as active is most mutual funds, but they are not entirely passive either.
- jackcosgrove 10y ago
  Active and passive are just marketing labels. The frequency of trades should be correlated with the expense ratio. If you do more trades, you better be hiring more analysts to figure out those trades. Vanguard has lower costs because it employs fewer people to execute fewer trades. That's all I really care about.
  - jessriedel 10y ago
    Expense ratios for actively managed funds aren't that tied to trading frequency, I don't think. Most of the cost goes to paying for research, and that can be for positions held on all time scales. Someone picking a handful of blue chip stocks based on fundamentals is still definitely "active investing" even if they buy and hold for a long time.
- kgwgk 10y ago
  Vanguard offers a range of products. Some do really hold the stocks in the benchmark. "Vanguard S&P 500 ETF is an exchange-traded share class of Vanguard 500 Index Fund. Using full replication, the portfolio holds all stocks in the same capitalization weighting as the index."
Chaebixi 10y ago
> My point is, the less active money there is around, the less accurate our concept of a correct value can be. This situation has the potential to de-stabilise the economy sooner rather than later. Could that be mitigated by people not completely jumping on the passive bandwagon (e.g. by keeping say 5% in active funds)? Wouldn't all that you need is an active enough and large enough market to resist manipulation?
collinmanderson 10y ago
Isn't the real issue that there wouldn't be as much liquidity? As more shares of a company are held by passive investors, the fewer are available to trade on a daily basis, right?
pembrook 10y ago
The flows to Vanguard are largely driven by retail investors and I think you are grossly overestimating the pricing value that "active" retail investors provide. Retail investors don't act as a rational pricing mechanism. 99% of them don't discount future cash flows, examine balance sheets, or evaluate growth prospects. In fact they statistically buy high and sell low which only serves to make boom and bust cycles more severe. They are the greater fools in the Greater Fool Theory. Turning "dumb" retail money into passive index fund flows can only serve to make markets more efficient and stable. That said, if I had to guess the massive flows to index funds will come to a grinding halt as soon as the next market correction. While indexing has historically been the best strategy over the long run, the low interest rate environment has made it appear to be the best strategy even in the short term. This is not normal and is due to the high correlation still lingering after the effects of QE. Once interest rates rise enough to make alternatives more appealing this will balance itself out since investors chase returns.
- hyperpape 10y ago
  What makes indexing worse in the short term?
  - random_comment 10y ago
    Volatility, i.e. greater dispersion of returns in the short term. http://www.investopedia.com/terms/v/volatility.asp http://www.investopedia.com/terms/v/volatility.asp
  - milesvp 10y ago
    To expand on random_comments mention of volatility. Volatility is a big deal. Stock markets can be expected to beat inflation by several percentage points over the "long run", but "long run" is often defined in economics as "greater than your life expectancy". So there's a chance that you'll have to pull money out before it has a chance to grow, or worse, after it's lost a lot of value. Generally you should avoid putting money into stock markets with anything less than a 10 year window unless you love risk. And you should never put your emergency fund in the stock market since stock market crashes and needing said emergency fund tend to be highly correlated, which means when you pull your money out, you are all but guaranteed to be selling low.
MR4D 10y ago
Your last sentence is terribly wrong, and unfortunately, many people share that mistaken view. Let me explain... Active managers go around with the notion that as they die off to be replaced by index funds, that there there will be no price-finding. But here's the thing - before managers, and before mutual funds, most people were buy and hold investors. There was very little "price discovery" compared to today, as most stocks sat on a shelf (literally, as people had paper certificates for the shares they owned). In that world, the price discovery function was quite small, but clearly adequate. Today, there are many highly-paid managers who "actively" manage money. ( I challenge the "actively" portion, because many are closet-indexers. If you google "active-share", you can find more about this.) But even if they aren't closet indexers, in any given year, most cannot beat their benchmark. When they can't beat their benchmark (which, ironically is an index), they are inefficient. That statement bears some emphasis - When Active managers cannot meet or beat their benchmarks, they are __REDUCING__ the market's efficiency. Put simply, they were wrong on what they thought the correct price should be, thereby hindering price discovery. Read that last paragraph again - it's extremely important. Also, note that there are many people on Wall Street who are highly compensated, and afraid that their jobs will go away because of indexing (note that the S&P 500 is only one index - there are hundreds of others, including MSCI and Russell indexes). They are right to be concerned. After all, as in anything in life, if you can't keep up with the benchmark, you will get cut. This happens in professional sports, people in college with poor grades, and anybody in a sales job. And it's been happening in finance since before any of us were born. One final note: Back in 2001, the US markets moved from fraction pricing to decimalization. In short, the price increments went from 1/16 of a dollar to 1/100 of a dollar (i.e. a penny). That's a six-fold improvement in pricing accuracy. To think that having less active money will destabilize our economy is unfounded.

bike4beer 10y ago

About ten years ago I sold some real estate and moved some money into a Vangaurd fund it was easy, took a few minutes to setup the account online, and transfer from my credit union to the fund. Done. Five years later I tried to get the money back, I tried online but the website always failed and told me to reset my password. Finally after months I called, after hours of waiting on the phone ( skype ) I was told it was a tech problem, and need to talk to tech. After months of playing tag I finally got past the password and it said that the new password was sent to my mail, but I have to 'login' to read the mail, and they will not send your mail 'internet mail', so now I can't get any communication, and still can't access. Whenever I call its always the same problem, its non-english speaking people, also they only do telephone support a few hours a day, its not 24 hours like say Fidelity. So now its been 10+ years, and I have never been able to make a withdrawl, when I call I always get a run around, there is no Vanguard office where I live, so there is no 'face' to make demands. When I make requests I never get a response. In summary, Vangaurd is a black-hole; Be careful I'm glad in this case its only $10k, I'm sure by the time I ever need the money they'll say it was an abandoned account the money passed to gov, most country's have such laws where an account abandoned say 3+ years the money goes to the general fund. Anybody else here have a similar 'vanguard story to tell'?

solaarphunk 10y ago

ETFs can be arbitraged much more efficiently due to creation/redemption features. There are market markers like Jane Street who do a ton of this. The more risky effect is that all stocks in an index become more correlated with it over time, leading to larger jumps in single names around earnings seasons when real information is released to the public.

fowl2 10y ago
well presumably in a market based on fact, changes should be focused around when information becomes available, right?

postozoan 10y ago

Yeah, the slow and steady rise of stock prices across the board is in large part just an effect of increased money supply. Sure, lifting along with that passively is cheap and reliable way to make money. But since these types of passive investments care little about how efficiently the beneficiaries make use of these investments, there's the danger that inefficient companies end up with too much capital. If that happens, you end up with resources such as labor being wasted. The efficient usage of the available resources is of course a much better indicator for the quality of the economy than the rise of stock prices.

matt_wulfeck 10y ago
> there's the danger that inefficient companies end up with too much capital I can't see why this is any kind of danger. Companies end up subjectively with "too much capital" all of the time in this market without being part of a large index. Look at tesla.

zip1234 10y ago

I think you have identified that this is a self-correcting problem but are selling yourself short by thinking that the economy will be destabilized. If everyone goes towards passive investments, there will be huge opportunities in active investment because the passive investing is not correctly identifying value. These opportunities are likely to cause an outflow from passive into active if that is where the money is.

TheCoelacanth 10y ago
And the market is so huge, that even a slight amount of mis-pricing is a huge opportunity for active investors. A systematic mis-pricing of 0.1% is worth $18 billion dollars. That means the incentive to try to exploit even a minuscule amount of mis-pricing is huge.
- wdewind 10y ago
  > A systematic mis-pricing of 0.1% is worth $18 billion dollars. Can you expand on what exactly that means?
  - scrooched_moose 10y ago
    I assume they're basing it on the combined market cap of the S&P 500 [1], the most common passive fund championed by Buffett [2]. At a market cap of $18 trillion, .1% would be $18 billion. Although, they may be basing it on old data, as of March 31 it's closer to $21.2 billion 1) http://siblisresearch.com/data/total-market-cap-sp-500/ http://siblisresearch.com/data/total-market-cap-sp-500/ 2) https://www.fool.com/investing/2017/02/26/warren-buffett-just-revealed-the-best-investment-m.aspx https://www.fool.com/investing/2017/02/26/warren-buffett-jus...
    - ethbro 10y ago
      I think the question might have been what a "systemic mispricing of 0.1%" means. If the majority of the market is passively rebalancing, does the true value matter or does the weighting swamp it? I see how one would make money on arbitraging pre- and post-90s mandatory rebalancing by major passives. I'm less clear on how one arbitrages difference between the prices passives are investing at and a "true" price.

lr4444lr 10y ago

If you're a Vanguard customer (buying the flagship fund classes, I presume), you're expressing faith in CAPM[0] and EMH[1] on a significant level. Some active investors will probably in the long term scoop up some extra gains, but the question still remains: which of them, over what time horizon, and is that a risk you want to take? Vanguard gives you lots of no-commission funds with 1 day liquidity even in the mutual funds - plenty of room for you to try and time the market if you think you can have a go at active trading around some predictable flows if too many people are passively investing. Nothing stops you. [0]http://www.investopedia.com/terms/c/capm.asp http://www.investopedia.com/terms/c/capm.asp [1]http://www.investopedia.com/terms/e/efficientmarkethypothesis.asp http://www.investopedia.com/terms/e/efficientmarkethypothesi...

dsacco 10y ago
I think the parent commenter is more concerned about the economy's overall stability, and believes passive investors could be exploited due to mis-pricing index fund underlyings. I didn't interpret it as a worry about missing out on active investment, but I could be wrong.
- headmelted 10y ago
  ^^ Effectively this. My concern is that if everyone is in the passive investing boat then we're no longer following the market, we're making the market, and it's a big departure from the philosophical under-pinnings behind the idea of passive investing. (We started out letting active players make the market by placing good/bad bets and winning/losing. We got a market that was at least trying to find the right price and we did well due to the low expense ratios. Now that we're in the majority, I'm concerned that no-one is trying to find the right price anymore.) tldr; I have mixed feelings about passive investing over the long term if we're no longer small fish in a big ocean.
  - pitt1980 10y ago
    what's a good hedge against this?
  - 10y ago

tryitnow 10y ago

It's been a looong time since I've studied financial economics but I do think there's an active research literature around this topic (under the topic of market microstructure maybe?). If I recall correctly (and again, it's been a while), I think the amount of passive funds has to be quite substantial for markets to be really bad at reflecting value over the long run.

L_Rahman 10y ago
And it's a recurring topic in Matt Levine's Money Stuff newsletter. The finance community is not only aware but actively thinking about the ramifications of the situation.

kolbe 10y ago

> the less active money there is around, the less accurate our concept of a correct value can be The problem is deeper than that. Active shareholders actually give a shit about corporate governance. Collectively, they put honorable and competent people on the board of directors, and make sensible decisions when other issues are put to shareholder votes. Vanguard and other indexing funds could barely care. Their incentive to care is so small, we may as well call it nothing. Whereas the employees who control these voting blocks at Vanguard can easily make decisions that cause 10,000x more financial impact than their total compensation. And whenever someone is endowed with such power, human behavior throughout our existence has shown most people will be corrupted by it (e.g. see government employees).

marcosdumay 10y ago
Yet, this is a general problem of all kinds of investment funds, not only of index ones. It is a huge problem (and probably responsible for much of the lawlessness we can find on Wall Street), but the switch from active to passive investment shouldn't change a thing.
- kolbe 10y ago
  It's not necessarily active vs passive. It's skin in the game vs no skin. Low fee index funds offer no incentive for the managers to do any actual managing. They follow an equation, and collect a few bps.
  - marcosdumay 10y ago
    Yes, it's not even that simple. It's about having enough skin on the game. No big fund manager has enough skin on the game. That has been true for most of last century and all of the current one, and the expected results are visibly there.
    - kolbe 10y ago
      This is why my push isn't to necessarily increase the active management profession, but instead increase the intelligence of individuals and freedom of necessary information for them to properly manage and understand their own assets. Even if they do just end up choosing to invest in a market cap weighted broad based index, it's important for them to understand how to behave with the management of those assets and to have the ability to manage them (see the distinction versus investing in index funds, because Vanguard's investors do not manage their assets). And if they do not have the requisite intelligence to manage and understand the things they own, maybe they shouldn't own them.

danmaz74 10y ago

> This situation has the potential to de-stabilise the economy sooner rather than later. If these passive investment funds create a positive feedback loop for some stock prices - I don't know if that's the case - then this could be a pretty high risk. On the other hand, I would intuitively expect them to have a dampening effect on the "pump and dump" schemes that created so many bubbles. So, in a way, they could even help stabilizing the markets?

pdog 10y ago

Active money is trading much faster these days. A smaller percentage is enough to make the market efficient. The outflow is mostly from active domestic equity mutual funds (average expense ratio: 1%-1.5%) to index domestic equity ETFs (average expense ratio: 0.1%-0.2%), so it's really about lower costs and the relative underperformance of active management.

reddytowns 10y ago

If most people ends up investing in strictly index funds, it would end up badly foe them but I don't see it by itself causing a destabilization. Just a lot of people making sub market profits. It would take a large amount of people doing fad based investing and switching all at once cause destabilization, such as what happened during the dot com bubble and the housing bubble. If investing decisions get slower in general, then I think it would be a good thing. The number of company decisions made only for only the next quarter rather than long term profitability would be much less if it took time for people to switch the companies they invest in rather than doing so instantly, which would in turn make a more efficient and stable market.

fictioncircle 10y ago

> My point is, the less active money there is around, the less accurate our concept of a correct value can be. This situation has the potential to de-stabilise the economy sooner rather than later. That won't happen (probably). The less accurate our concept of correct value is, the more competition it will draw as the margins increase. Realistically, we can be probably something absurd like 80% passive funds and 20% active investors and be fine.

yborg 10y ago

>such a small share of such a large market I think you underestimate the size of the active players in the market, especially considering leverage, which they generally are to the hilt.

bluGill 10y ago

Vanguard is not as passive as you think. they don't trade often, but they do trade. Their S&P500 fund doesn't just hold stocks in the S&P500, it also holds other stocks that could have been but S&P500 had S&P not limited the index to 500 stocks. Vanguard fund managers regularly make active decisions on what stocks to buy/sell. Vanguard is not nearly as active is most mutual funds, but they are not entirely passive either.

jackcosgrove 10y ago
Active and passive are just marketing labels. The frequency of trades should be correlated with the expense ratio. If you do more trades, you better be hiring more analysts to figure out those trades. Vanguard has lower costs because it employs fewer people to execute fewer trades. That's all I really care about.
- jessriedel 10y ago
  Expense ratios for actively managed funds aren't that tied to trading frequency, I don't think. Most of the cost goes to paying for research, and that can be for positions held on all time scales. Someone picking a handful of blue chip stocks based on fundamentals is still definitely "active investing" even if they buy and hold for a long time.
kgwgk 10y ago
Vanguard offers a range of products. Some do really hold the stocks in the benchmark. "Vanguard S&P 500 ETF is an exchange-traded share class of Vanguard 500 Index Fund. Using full replication, the portfolio holds all stocks in the same capitalization weighting as the index."

Chaebixi 10y ago

> My point is, the less active money there is around, the less accurate our concept of a correct value can be. This situation has the potential to de-stabilise the economy sooner rather than later. Could that be mitigated by people not completely jumping on the passive bandwagon (e.g. by keeping say 5% in active funds)? Wouldn't all that you need is an active enough and large enough market to resist manipulation?

collinmanderson 10y ago

Isn't the real issue that there wouldn't be as much liquidity? As more shares of a company are held by passive investors, the fewer are available to trade on a daily basis, right?

pembrook 10y ago

The flows to Vanguard are largely driven by retail investors and I think you are grossly overestimating the pricing value that "active" retail investors provide. Retail investors don't act as a rational pricing mechanism. 99% of them don't discount future cash flows, examine balance sheets, or evaluate growth prospects. In fact they statistically buy high and sell low which only serves to make boom and bust cycles more severe. They are the greater fools in the Greater Fool Theory. Turning "dumb" retail money into passive index fund flows can only serve to make markets more efficient and stable. That said, if I had to guess the massive flows to index funds will come to a grinding halt as soon as the next market correction. While indexing has historically been the best strategy over the long run, the low interest rate environment has made it appear to be the best strategy even in the short term. This is not normal and is due to the high correlation still lingering after the effects of QE. Once interest rates rise enough to make alternatives more appealing this will balance itself out since investors chase returns.

hyperpape 10y ago
What makes indexing worse in the short term?
- random_comment 10y ago
  Volatility, i.e. greater dispersion of returns in the short term. http://www.investopedia.com/terms/v/volatility.asp http://www.investopedia.com/terms/v/volatility.asp
- milesvp 10y ago
  To expand on random_comments mention of volatility. Volatility is a big deal. Stock markets can be expected to beat inflation by several percentage points over the "long run", but "long run" is often defined in economics as "greater than your life expectancy". So there's a chance that you'll have to pull money out before it has a chance to grow, or worse, after it's lost a lot of value. Generally you should avoid putting money into stock markets with anything less than a 10 year window unless you love risk. And you should never put your emergency fund in the stock market since stock market crashes and needing said emergency fund tend to be highly correlated, which means when you pull your money out, you are all but guaranteed to be selling low.

MR4D 10y ago

Your last sentence is terribly wrong, and unfortunately, many people share that mistaken view. Let me explain... Active managers go around with the notion that as they die off to be replaced by index funds, that there there will be no price-finding. But here's the thing - before managers, and before mutual funds, most people were buy and hold investors. There was very little "price discovery" compared to today, as most stocks sat on a shelf (literally, as people had paper certificates for the shares they owned). In that world, the price discovery function was quite small, but clearly adequate. Today, there are many highly-paid managers who "actively" manage money. ( I challenge the "actively" portion, because many are closet-indexers. If you google "active-share", you can find more about this.) But even if they aren't closet indexers, in any given year, most cannot beat their benchmark. When they can't beat their benchmark (which, ironically is an index), they are inefficient. That statement bears some emphasis - When Active managers cannot meet or beat their benchmarks, they are __REDUCING__ the market's efficiency. Put simply, they were wrong on what they thought the correct price should be, thereby hindering price discovery. Read that last paragraph again - it's extremely important. Also, note that there are many people on Wall Street who are highly compensated, and afraid that their jobs will go away because of indexing (note that the S&P 500 is only one index - there are hundreds of others, including MSCI and Russell indexes). They are right to be concerned. After all, as in anything in life, if you can't keep up with the benchmark, you will get cut. This happens in professional sports, people in college with poor grades, and anybody in a sales job. And it's been happening in finance since before any of us were born. One final note: Back in 2001, the US markets moved from fraction pricing to decimalization. In short, the price increments went from 1/16 of a dollar to 1/100 of a dollar (i.e. a penny). That's a six-fold improvement in pricing accuracy. To think that having less active money will destabilize our economy is unfounded.