7 ms·

The rise of passive investors

116 points by jboynyc 9y ago

jboynyc 9y ago
The paper this is based on is open access: https://doi.org/10.1017/bap.2017.6 https://doi.org/10.1017/bap.2017.6
surrealize 9y ago
I'm generally against concentrated market power, so I'm definitely sympathetic to the point and I think it's good to be aware of this concentration of ownership. I'm not sure this is totally fair, though: > We found that the Big Three, taken together, have become the largest shareholder in 40% of all publicly listed firms in the United States. > Together, the Big Three are the largest single shareholder in almost 90% of S&P 500 firms > The Big Three – seen together – are virtually always the largest shareholder in the few competitors that remain in these sectors. They're aggregating these owners together, then saying that the aggregation is larger than the non-aggregated other owners. That's not too surprising, right? Taken together, the vowels cover more of the alphabet than any other single letter. Undoubtedly true, but what does that really tell us? If the big three tend to vote with management, that sounds potentially concerning. But are they just not voting for wacky shareholder proposals? What proportion of those votes actually tip the outcome? The section on the potential impact of this ownership concentration has a lot of "could have" and "may be" in it. We should definitely be doing that research, but at this stage the story isn't super compelling.
- empath75 9y ago
  I feel like they should delegate their votes somehow to the people they are actually buying shares for. I don't know what the right mechanism is, but it seems wrong that by investing in a passive fund, I've also given up the right to vote with my shares.
  - kasey_junk 9y ago
    You are specifically doing that by investing in a fund. You can build the underlying basket yourself if you want the voting rights.
- lotsofpulp 9y ago
  The analysis leaves much to be desired, namely what has been and will be the effect of pooling all this money in passive investment funds, but I guess it's still newsworthy to note of this change in the investing environment (if true). Personal opinion is all this consolidation into 2 or 3 companies dominating various fields will not bode well in the long term. Once you have enough people invested in something, it's tough to let it fail (politically), so you have a situation like 2008 where the people that made bad decisions were bailed out creating bad incentives and moral hazard going forward just because enough voters were negatively affected because everyone was invested in the same things. Of course, 2008 wasn't the first time that happened, and it won't be the last, but I assume the cycle will continue until we reach a breaking point and the game is reset.
mattmanser 9y ago
A friend told me on Monday about an idea he'd just read that in fact shareholders should be the least important of all in a company's consideration and the US/UK maximize share-holder value laws/attitude is actually damaging. The gist of the argument was: - Shareholders have no long-term investment in a company, they can easily move their money if they feel a company is performing badly. They can have little interest in long-term survival. - Employees and suppliers do have long-term investment, have barriers to moving their commitment Therefore you should discard the concept that a companies should maximize share-holder value and should instead incentivize companies to focus on long-term survival. The example cited was GM, which did share buybacks instead of saving cash in boom times and then went bust because it ran out of cash in a recession. I'm yet to read the book (which I can't remember the title now), but it sounds interesting and would be an effective counter to this concentration.
- johanvts 9y ago
  Who are "you" in this case? If "you" are the employees "you" might naturally have an entirely different view of what to optimize for than if "you" are the shareholder. The promise of capitalism is that if we all optimize for our own benefit, the invisible hand will make everyone better off.
  - pc86 9y ago
    First of all, capitalism does not "promise" anything. Secondly, it says that in aggregate, society will be better off in everyone focuses more or less on their individual interests. It does not suggest that everyone in that society will be better off. In some hypothetical world, if you raise the median income 50% and increase the quality of life for 95% of the population, while causing the other 5% to end up in crippling poverty for the rest of their life, you've made that society better in aggregate but certainly not for that 5%.
  - mattmanser 9y ago
    The you is society in theory, a government in reality.
- 9y ago
majewsky 9y ago
Why is the index-fund market is so concentrated? Shouldn't it be incredibly easy to break into this market?
- w23j 9y ago
  But how would you compete against the established companies? It cannot be higher returns, because all index-funds are supposed to have roughly the same returns (if they mirror the same index). So it must be lower fees. And you are able to charge lower fees if the total amount of money you manage is big. (Because a tiny percentage of a huge sum will still cover your costs.) The established players already manage a few trillion dollars, so it is hard to compete against them in this area.
  - Vinalin 9y ago
    Absolutely correct. Also, in the case of Vanguard, they're known as an "At-Cost" company. This means that they take no profit from the investors, and instead will return any excess money in the form of higher returns. This makes it very difficult to operate a profitable business in this space.
    - Jonnax 9y ago
      How does their business model work then? Subscription fees?
      - dx034 9y ago
        They're essentially not-for-profit. So no business model other than serving clients and covering costs.
      - Mindless2112 9y ago
        Vanguard is structured as a mutual company; it is owned by funds managed by the company, and is therefore owned by its customers. [1] So its owners have no incentive to increase fees in order to increase profits. Actually, Vanguard has been sued over this [2][3] -- the claim essentially being that Vanguard ought to owe taxes on those profits that it didn't earn from fees that it didn't charge. [1] https://en.wikipedia.org/wiki/The_Vanguard_Group https://en.wikipedia.org/wiki/The_Vanguard_Group [2] https://www.nytimes.com/2016/02/07/your-money/vanguard-a-champion-of-low-fees-faces-a-peculiar-tax-challenge.html?mcubz=0 https://www.nytimes.com/2016/02/07/your-money/vanguard-a-cha... [3] https://news.ycombinator.com/item?id=11081550 https://news.ycombinator.com/item?id=11081550
saimiam 9y ago
This book I'm reading discusses the ill-effects of stock ownership by huge hedge funds. The authors call it grey capitalism where nameless, faceless money managers deploy huge swaths of capital to own companies but don't actually participate in their running. It's hurting innovation because now the company is beholden to these owners who never show up or look at the big picture. Their window of caring about the company is a quarter to a year at best which is reset after every earnings call.
- grogenaut 9y ago
  Link?
  - saimiam 9y ago
    https://www.amazon.com/Innovation-Illusion-Little-Created-Working/dp/0300217404/ref=sr_1_1 https://www.amazon.com/Innovation-Illusion-Little-Created-Wo...
shalmanese 9y ago
Matt Levine over at Bloomberg [1] has over time written a lot of intelligent stuff about the issues posed by the increasing dominance of index funds. I find him to be one of the best finance writers around for being able to incisively cut through a lot of the blather and obfuscation and get to the heart of the issue. https://www.bloomberg.com/view/topics/money-stuff https://www.bloomberg.com/view/topics/money-stuff
- simonsarris 9y ago
  Levine really is an excellent writer, a joy to read almost irrespective of subject.
twoquestions 9y ago
This is the kind of thing I fear. While most of us are rightly afraid of a Soviet-style central planning, we were blind to private central planners like this controlling our economy. We're nowhere near the level of dystopian control that Soviet central planners had, but the trend is leaning closer to that than farther away, what with companies listening to their investors before their customers.
- ihsw2 9y ago
  Did you read the article? The article mentions that control may be more centralized than before but its impact is limited to simply favoring stocks that are perceived to exist for an extended period of time and consistently tick upward in price. Furthermore the article specifically mentions that its impact is limited because index funds are more "hands-off" than anything else. This implies there is not more central planning, and (more to the point) there is no planning -- just a reflexive response to stock price movement. This is the purest expression of the "invisible hand of the market."
  - usrusr 9y ago
    I don't think that they are mutually exclusive: they could be perfectly hands-off regarding strategy, but still be stuffing the board with people who are prone to playing personal favor-swapping games with individuals in the fund management.
  - dang 9y ago
    Please don't insinuate that someone hasn't read an article. "Did you even read the article? It mentions that" can be shortened to "The article mentions that." https://news.ycombinator.com/newsguidelines.html https://news.ycombinator.com/newsguidelines.html
- IsaacL 9y ago
  "Private central planning" is a contradiction. Nothing stops people creating competing funds, investing their savings in said funds, or investing directly in companies. I.e. in the private sector there's always the threat of competition, which changes the dynamic completely. Granted it is a problem that 3 firms are so dominant.
castratikron 9y ago
That you essentially waive your voting rights by investing in mutual funds is a downside that usually isn't brought up in investing guides. The usual advise is that, for most people, mutual funds are "better" than owning individual stocks, and that index funds are "better" than actively managed funds because most managers can't beat the market and can't justify the higher fees. But each level of indirection dilutes your individual power to vote. Shareholder voting really does make a difference. Here's one case where the big three voted against management (for what I think were the right reasons): https://www.washingtonpost.com/news/energy-environment/wp/2017/05/31/exxonmobil-is-trying-to-fend-off-a-shareholder-rebellion-over-climate-change/ https://www.washingtonpost.com/news/energy-environment/wp/20...
jtcond13 9y ago
The 'rise of passive investors' creates more opportunities for activist investors to discover overvalued/undervalued stocks. Index funds aren't affecting the prices of individual stocks. So long as the opportunity exists to make money buy buying/shorting stocks, someone will be buying/shorting stocks. Moreover, executive compensation is still overwhelmingly set via earnings-per-share targets in a fairly transparent manner. If there's a conspiracy afoot to miss targets to benefit an industry sector, the authors haven't identified it. I like the Matt Levine treatment of this question ('Are Index Funds Communist?'): https://www.bloomberg.com/view/articles/2016-08-24/are-index-funds-communist https://www.bloomberg.com/view/articles/2016-08-24/are-index...

116 points by jboynyc 9y ago

The paper this is based on is open access: https://doi.org/10.1017/bap.2017.6 https://doi.org/10.1017/bap.2017.6

I'm generally against concentrated market power, so I'm definitely sympathetic to the point and I think it's good to be aware of this concentration of ownership. I'm not sure this is totally fair, though: > We found that the Big Three, taken together, have become the largest shareholder in 40% of all publicly listed firms in the United States. > Together, the Big Three are the largest single shareholder in almost 90% of S&P 500 firms > The Big Three – seen together – are virtually always the largest shareholder in the few competitors that remain in these sectors. They're aggregating these owners together, then saying that the aggregation is larger than the non-aggregated other owners. That's not too surprising, right? Taken together, the vowels cover more of the alphabet than any other single letter. Undoubtedly true, but what does that really tell us? If the big three tend to vote with management, that sounds potentially concerning. But are they just not voting for wacky shareholder proposals? What proportion of those votes actually tip the outcome? The section on the potential impact of this ownership concentration has a lot of "could have" and "may be" in it. We should definitely be doing that research, but at this stage the story isn't super compelling.

empath75 9y ago
I feel like they should delegate their votes somehow to the people they are actually buying shares for. I don't know what the right mechanism is, but it seems wrong that by investing in a passive fund, I've also given up the right to vote with my shares.
- kasey_junk 9y ago
  You are specifically doing that by investing in a fund. You can build the underlying basket yourself if you want the voting rights.
lotsofpulp 9y ago
The analysis leaves much to be desired, namely what has been and will be the effect of pooling all this money in passive investment funds, but I guess it's still newsworthy to note of this change in the investing environment (if true). Personal opinion is all this consolidation into 2 or 3 companies dominating various fields will not bode well in the long term. Once you have enough people invested in something, it's tough to let it fail (politically), so you have a situation like 2008 where the people that made bad decisions were bailed out creating bad incentives and moral hazard going forward just because enough voters were negatively affected because everyone was invested in the same things. Of course, 2008 wasn't the first time that happened, and it won't be the last, but I assume the cycle will continue until we reach a breaking point and the game is reset.

mattmanser 9y ago

A friend told me on Monday about an idea he'd just read that in fact shareholders should be the least important of all in a company's consideration and the US/UK maximize share-holder value laws/attitude is actually damaging. The gist of the argument was: - Shareholders have no long-term investment in a company, they can easily move their money if they feel a company is performing badly. They can have little interest in long-term survival. - Employees and suppliers do have long-term investment, have barriers to moving their commitment Therefore you should discard the concept that a companies should maximize share-holder value and should instead incentivize companies to focus on long-term survival. The example cited was GM, which did share buybacks instead of saving cash in boom times and then went bust because it ran out of cash in a recession. I'm yet to read the book (which I can't remember the title now), but it sounds interesting and would be an effective counter to this concentration.

johanvts 9y ago
Who are "you" in this case? If "you" are the employees "you" might naturally have an entirely different view of what to optimize for than if "you" are the shareholder. The promise of capitalism is that if we all optimize for our own benefit, the invisible hand will make everyone better off.
- pc86 9y ago
  First of all, capitalism does not "promise" anything. Secondly, it says that in aggregate, society will be better off in everyone focuses more or less on their individual interests. It does not suggest that everyone in that society will be better off. In some hypothetical world, if you raise the median income 50% and increase the quality of life for 95% of the population, while causing the other 5% to end up in crippling poverty for the rest of their life, you've made that society better in aggregate but certainly not for that 5%.
- mattmanser 9y ago
  The you is society in theory, a government in reality.
9y ago

majewsky 9y ago

Why is the index-fund market is so concentrated? Shouldn't it be incredibly easy to break into this market?

w23j 9y ago
But how would you compete against the established companies? It cannot be higher returns, because all index-funds are supposed to have roughly the same returns (if they mirror the same index). So it must be lower fees. And you are able to charge lower fees if the total amount of money you manage is big. (Because a tiny percentage of a huge sum will still cover your costs.) The established players already manage a few trillion dollars, so it is hard to compete against them in this area.
- Vinalin 9y ago
  Absolutely correct. Also, in the case of Vanguard, they're known as an "At-Cost" company. This means that they take no profit from the investors, and instead will return any excess money in the form of higher returns. This makes it very difficult to operate a profitable business in this space.
  - Jonnax 9y ago
    How does their business model work then? Subscription fees?
    - dx034 9y ago
      They're essentially not-for-profit. So no business model other than serving clients and covering costs.
    - Mindless2112 9y ago
      Vanguard is structured as a mutual company; it is owned by funds managed by the company, and is therefore owned by its customers. [1] So its owners have no incentive to increase fees in order to increase profits. Actually, Vanguard has been sued over this [2][3] -- the claim essentially being that Vanguard ought to owe taxes on those profits that it didn't earn from fees that it didn't charge. [1] https://en.wikipedia.org/wiki/The_Vanguard_Group https://en.wikipedia.org/wiki/The_Vanguard_Group [2] https://www.nytimes.com/2016/02/07/your-money/vanguard-a-champion-of-low-fees-faces-a-peculiar-tax-challenge.html?mcubz=0 https://www.nytimes.com/2016/02/07/your-money/vanguard-a-cha... [3] https://news.ycombinator.com/item?id=11081550 https://news.ycombinator.com/item?id=11081550

saimiam 9y ago

This book I'm reading discusses the ill-effects of stock ownership by huge hedge funds. The authors call it grey capitalism where nameless, faceless money managers deploy huge swaths of capital to own companies but don't actually participate in their running. It's hurting innovation because now the company is beholden to these owners who never show up or look at the big picture. Their window of caring about the company is a quarter to a year at best which is reset after every earnings call.

grogenaut 9y ago
Link?
- saimiam 9y ago
  https://www.amazon.com/Innovation-Illusion-Little-Created-Working/dp/0300217404/ref=sr_1_1 https://www.amazon.com/Innovation-Illusion-Little-Created-Wo...

shalmanese 9y ago

Matt Levine over at Bloomberg [1] has over time written a lot of intelligent stuff about the issues posed by the increasing dominance of index funds. I find him to be one of the best finance writers around for being able to incisively cut through a lot of the blather and obfuscation and get to the heart of the issue. https://www.bloomberg.com/view/topics/money-stuff https://www.bloomberg.com/view/topics/money-stuff

simonsarris 9y ago
Levine really is an excellent writer, a joy to read almost irrespective of subject.

twoquestions 9y ago

This is the kind of thing I fear. While most of us are rightly afraid of a Soviet-style central planning, we were blind to private central planners like this controlling our economy. We're nowhere near the level of dystopian control that Soviet central planners had, but the trend is leaning closer to that than farther away, what with companies listening to their investors before their customers.

ihsw2 9y ago
Did you read the article? The article mentions that control may be more centralized than before but its impact is limited to simply favoring stocks that are perceived to exist for an extended period of time and consistently tick upward in price. Furthermore the article specifically mentions that its impact is limited because index funds are more "hands-off" than anything else. This implies there is not more central planning, and (more to the point) there is no planning -- just a reflexive response to stock price movement. This is the purest expression of the "invisible hand of the market."
- usrusr 9y ago
  I don't think that they are mutually exclusive: they could be perfectly hands-off regarding strategy, but still be stuffing the board with people who are prone to playing personal favor-swapping games with individuals in the fund management.
- dang 9y ago
  Please don't insinuate that someone hasn't read an article. "Did you even read the article? It mentions that" can be shortened to "The article mentions that." https://news.ycombinator.com/newsguidelines.html https://news.ycombinator.com/newsguidelines.html
IsaacL 9y ago
"Private central planning" is a contradiction. Nothing stops people creating competing funds, investing their savings in said funds, or investing directly in companies. I.e. in the private sector there's always the threat of competition, which changes the dynamic completely. Granted it is a problem that 3 firms are so dominant.

castratikron 9y ago

That you essentially waive your voting rights by investing in mutual funds is a downside that usually isn't brought up in investing guides. The usual advise is that, for most people, mutual funds are "better" than owning individual stocks, and that index funds are "better" than actively managed funds because most managers can't beat the market and can't justify the higher fees. But each level of indirection dilutes your individual power to vote. Shareholder voting really does make a difference. Here's one case where the big three voted against management (for what I think were the right reasons): https://www.washingtonpost.com/news/energy-environment/wp/2017/05/31/exxonmobil-is-trying-to-fend-off-a-shareholder-rebellion-over-climate-change/ https://www.washingtonpost.com/news/energy-environment/wp/20...

jtcond13 9y ago

The 'rise of passive investors' creates more opportunities for activist investors to discover overvalued/undervalued stocks. Index funds aren't affecting the prices of individual stocks. So long as the opportunity exists to make money buy buying/shorting stocks, someone will be buying/shorting stocks. Moreover, executive compensation is still overwhelmingly set via earnings-per-share targets in a fairly transparent manner. If there's a conspiracy afoot to miss targets to benefit an industry sector, the authors haven't identified it. I like the Matt Levine treatment of this question ('Are Index Funds Communist?'): https://www.bloomberg.com/view/articles/2016-08-24/are-index-funds-communist https://www.bloomberg.com/view/articles/2016-08-24/are-index...