16 ms·

The growth in passive funds has caused markets to become more correlated?

178 points by abhi3 8y ago

mr_toad 8y ago
Is Bloomberg a tabloid? The answer may shock you!
- analog31 8y ago
  That depends on how you fold a website. ;-)
dang 8y ago
The article is interesting. We replaced the baity title with representative language from the text. Hopefully that will spare us all yet another boring flamewar about the c-word. If anyone can suggest a more accurate and neutral title, we can change it again. Edit: ok, you guys didn't like "When analysts are replaced with index funds, the market stops allocating capital", so I dug up another representative sentence from the article. The best way to complain about a title is to offer a better one, so if you don't like this one either, maybe take a crack at it?
- deleted 8y ago
  [deleted]
- tanderson92 8y ago
  The "index funds" thing is throwing people off the track of the article, which is more about robots than index funds proper. Perhaps "when human analysts are replaced with algorithmic robots, capital markets will feature less activity but what about efficiency?".
  - dang 8y ago
    It needs to be 80 chars or less.
- loeg 8y ago
  The replacement text is worse — it's still baity in the same way, but differs arbitrarily from the headline.
  - dang 8y ago
    That's why I asked for help with a replacement. The article's headline breaks the site guidelines (https://news.ycombinator.com/newsguidelines.html https://news.ycombinator.com/newsguidelines.html), so obviously we can't keep that one.
PopePompus 8y ago
This article brings up a point I used to worry about - if people are just automatically pumping money into a list of stocks, how does the price remain connected to reality?. But apparently the answer is that mis-priced stocks present an arbitrage opportunity (https://www.investopedia.com/terms/i/indexarbitrage.asp https://www.investopedia.com/terms/i/indexarbitrage.asp), so as long as a few people are paying attention, the price remains rational, and the remaining people paying attention are rewarded for doing so. The Economist had an article about this issue recently and they concluded that the main effect of Index Funds was to drive low-performance fund managers out of business.
- deleted 8y ago
  [deleted]
- prostoalex 8y ago
  To quote somebody I heard on a Goldman Sachs podcast, "When everyone is seeking alpha, there's money to be made in beta, and vice versa".
- erik_seaberg 8y ago
  When $3B net income isn't an obstacle to a $1T market cap, reality is sort of optional.
  - akvadrako 8y ago
    I assume you are talking about Amazon. Who cares about past income? What matters is future earnings and it's clear they have lots of earnings potential.
    - sinsterizme 8y ago
      Yeah they do. But a $1T valuation implies a crazy amount of cash flow growth. They're top-line is increasing at 20%-30% per year right now but how long can that continue
- dustingetz 8y ago
djrogers 8y ago
The conclusions here seem to be based on a) a purely passive market, and b) a static amount of capital. I’d like to see an analysis that offsets the potential inefficiency of a partially passive market with the gains to the economy from additional capital being available to invest. Are we better or worse off with a market that is n% less efficient, but that has y% more capital from passive investors than a purely active market would have?
jameslk 8y ago
Once they've found the perfect capital allocation algorithm to replace markets, they can work on the perfect policy calculating algorithm to replace democracy Edit: /s
- UncleEntity 8y ago
  I think they will never find the perfect capital allocation algorithm or solve the economic calculation problem. There's just too many self-interested market actors to possibly be able to predict what their future wants will be to throw out the function that the entrepreneur provides, those who predict future wants correctly make money and those who don't lose their investment. Unless, of course, all they want is a static model of current consumption at the expense of human progress.
  - jameslk 8y ago
    I'd be more concerned about the potential conflict of interest having such algorithms control major functions of other's lives. My post was meant to be sarcastic, however I'm getting a lot of downvotes, so perhaps the sarcasm wasn't clear.
ISL 8y ago
To me, the interesting question is: if the market is mostly index funds, what does that do? Lots of passive money means that the market is an amplifier for the decisions of those who choose to make their own decisions. Want $AMZN to have a little more market capitalization? Buy some, and the entire market is forced to follow you. Sell some, and they will follow you, too. It is herd behavior (which can be quite beneficial), but it affords certain advantages to those wily enough to use the herd instinct for their own designs.
- ucaetano 8y ago
  > To me, the interesting question is: if the market is mostly index funds, what does that do? This will never happen. It might be interesting, but isn't a realistic scenario.
  - prostoalex 8y ago
    Why?
    - ucaetano 8y ago
      I posted it here: https://news.ycombinator.com/item?id=18145067 https://news.ycombinator.com/item?id=18145067 But essentially, as % of market on index funds increases, the returns on arbitrage-seeking actively managed portfolios will increase (vs. the market) to the point that they provide higher returns than the index funds (due to index funds no longer accurately capturing all information available in the market), resulting in a shift of money out of index funds to active funds, decreasing the returns in active funds and keeping the market in equilibrium.
- brisance 8y ago
  The "you" refers to the "index fund manager", yes? If so, then your thesis doesn't make sense. The index fund manager's job is to maintain the fund's allocation according to the index calculation to the best of his ability, not "go out and buy some $AMZN cos it looks cheap" (which opens up the fund for civil lawsuits for not adhering to the prospectus), or to "manipulate the herd". Tracking errors happen, but those are incidental to the need for re-balancing and are not outright actions undertaken by the fund manager for the purposes stated above.
jorblumesea 8y ago
If you went to a financial advisor 30 years ago, they would have said "give me your money and I'll make you a portfolio". He/she would then have bought most of the S&P 500 or some other exchange in a diversified manner buying equities and bonds. They would have shifted around your allocations ever so slightly every quarter, buying some stocks and selling others. But really, the strategy was to buy and hold. Bonds were similar. Is that not indexing under another name?
- kgwgk 8y ago
  He would not buy “most of the s&p 500”. He would pick stocks to (try to) do better than the s&p 500. Indexing was not common 30 years ago. http://s18674.pcdn.co/wp-content/uploads/2015/05/Index-market-share.jpg http://s18674.pcdn.co/wp-content/uploads/2015/05/Index-marke...
  - jorblumesea 8y ago
    Indexing was very common, it just wasn't called indexing. It was called "active investing" but the reality is it wasn't as active or as smart as people think it was. It was very similar to today's indexing where you would funnel your money into the Facebook, Google, Amazon's of the day and collect a fat fee. This is how index funds work today, when you invest in a S&P 500 index fund it's really weighted towards the huge hitters. The dirty secret of active investing is every active investor had some kind of index-like fund going that constituted a large percentage of their portfolio. That graph is precisely my point, it's all about how we're measuring what it means to be an "index". You could engage in index-like behavior but be an "active investor". Indexing is just a label.
    - kgwgk 8y ago
      Of course the market as a whole has been always indexing by mathematical necessity. Indexing is just a label, true, but it happens to be the label applied to investing exactly in proportion to the weight of each stock in the index. As opossed to "active investing".
wmnwmn 8y ago
The market already doesn't allocate capital. Companies almost never issue new shares, indeed they buy them back. Given that dividends are also trifling, the market is mainly a large scale gambling scheme. Not entirely, but mainly.
- koboll 8y ago
  That's why I love index funds. You're betting with the house, not against it.
- khuey 8y ago
  Companies issue new shares all the time. Tech company stock buyback programs are often treading water against employee equity compensation.
sysk 8y ago
> The function of the capital markets is to allocate capital. I never fully grasped this idea. I have no problem understanding that venture capitalists, angel investors or investors that buy shares at IPO do allocate capital. However, why is trading existing shares considered "allocating capital"?
- tedsanders 8y ago
  Every purchase of a share rewards the previous owner with some cash. Follow that chain of trades backward and eventually you end up rewarding the founder, the early employees, the VCs, etc. It's a long, tenuous chain, but it's there. I agree with the general point that most trades of mature companies don't seem to have a material effect on the expectations of today's founders, early employees, VCs, etc. Though in theory if liquidity dried up enough or valuations fell, those signals would noisily backpropagate through prices and shift expectations of rewards.
  - sysk 8y ago
    I understand the concept of liquidity and the reward mechanism you describe but it doesn't ultimately answer my question, which why is the process of buying an existing share called "capital allocation"? Let's say I buy a GOOG share from Larry Page. Is it the idea that I "allocated capital" to Larry Page's bank account? It seems to me like the correct thing to say would be that I provided liquidity to Larry, not that I allocated capital. Or is it the idea that I allocated some of my own capital to the stock market?
    - roenxi 8y ago
      Two points, one going to your question and one is of general interest. Buying existing shares is "capital allocation" with respect to the _buyer's capital_. So I might allocate 20% of my capital (ie, gross financial worth) to being in shares of some company. The seller is allocating their capital somewhere other than the share. So you allocate your capital to GOOG, pay Larry and notify Alphabet that you are one of their capitalist overlords. If the price of Alphabet stock goes up, you now have more capital even though if you do a quick count you'll discover you have no new currency/cash. The reason this is important is that the people with a good ability to allocate capital will end up with more capital hence control. Eventually, the people in charge will be the people with a good grasp of what is changing (which I'll claim is desirable with no support). For general interest, I've no insight into the intricacies of the US system, but in Australia every so often a company creates and sells new shares directly on the market. The upshot of this is a company can access the market directly for capital.
ucaetano 8y ago
This is fearmongering. If the market approached an allocation to index funds that enabled arbitrage, more actors would switch to arbitrage eliminating such arbitrage. It is a self-balancing situation. A scenario of "oh my god, everyone is just putting their money on index funds" would never happen. Another way to think about it is in terms of evolutionary stable strategy. Index funds and arbitrage-seeking reach a Nash equilibrium at some point (far more index-allocated than today's market) where arbitrage-seekers will reap returns almost equal to index funds, as index allocation starts o not capture all available market information. If the market deviates from that point, forces push it back into that point. If the market starts over-allocating into arbitrage-seeking (like today), returns on index funds will beat arbitrage, pushing capital back into index funds. If the market over-allocates in index funds, index funds will return below arbitrage, pushing money out of index funds. Edit: Right now, the market is still far over-allocated into the arbitrage-seeking side, resulting in a natural shift to index funds.
- prostoalex 8y ago
  To initiate a transaction an arbitrageur, though, needs a counter-party that's also engaged in arbitraging, but has an opposite opinion. Thought experiment - let's say there's an imaginary country that has 100 companies listed publicly, each floating 1,000 shares. Most citizens prefer indexing so 99,000 shares are owned by a bunch of Country 100 index funds. Those index funds will only trade on inflow/outflow into their own fund, never on corporate earnings, board changes, product announcements or other external event. What opportunities are there for arbitrageurs?
  - darawk 8y ago
    Someone has to sell to them when they get inflow and buy from them when they get outflow. Who do you think that will be?
    - fjsolwmv 8y ago
      That would be wage savers buying from retirees who are cashing out, both with market orders, not limit orders.
blazespin 8y ago
The biggest danger of all this money in index funds is that the market becomes to big to fail and the government has to keep propping it up. In fact, it becomes a way to actually disburse wealth - enact policies such that they go to people in the market.
- fma 8y ago
  China did that in 2015 when stock were tanking. "...forced state-owned brokers to promise to buy stocks until the index reached a higher level, mobilized state-controlled funds to purchase equities, and promised unlimited support from the central bank. " https://www.brookings.edu/opinions/making-sense-of-chinas-stock-market-mess/ https://www.brookings.edu/opinions/making-sense-of-chinas-st...
  - C1sc0cat 8y ago
    They tried that in 1929 with the Great Crash - it didn't work long-term.
- lotsofpulp 8y ago
  It’s not index funds that cause the market to be too big to fail. Pension fund investments and 401k investments also go to the same place, index funds just take out the middle man and reduce costs. And yes, that’s why you should be long on mid-large cap equity indexes, because they will always get bailed out, since too many voters are too invested in them. Either more money will be printed or cash infusion or loans from taxpayer, but in any case, the biggest sectors will never fail completely as they will always be re-inflated (in the US, as long as its currency and military continue to have the most power).
darawk 8y ago
This narrative is such a joke, and such a profound misunderstanding of economics i'm surprised Bloomberg would publish it. Simple rule: if your argument implies that there is or will be free money to be made in the stock market, your argument is probably wrong.
Terr_ 8y ago
This is equivalent to worrying that all the animals in the entire world might eventually become helpless herbivores. Relevant past topic: https://news.ycombinator.com/item?id=12368136 https://news.ycombinator.com/item?id=12368136
3pt14159 8y ago
It's actually a great article with a HN title that misrepresents what it is actually about. Anyway, with that proviso, here is my take: So long as the bots aren't conscious there will be no bot-dominated stock market. Too much information is wrapped up in conscious thought that isn't easily expressed in stock market pattern matching. The article mentions that the line between active and passive isn't as clear as people that make it out to be say it is, and that is true, but it's also incomplete. Certain events are conceivable to humans that are not conceivable to machines. Short of simulating humans, anyway. For example, I as a human know that there is a non-zero chance that the DPRK and USA get into a nuclear war. I can know that Trump defaulting on Chinese held US debt is something that is at least on the table. The quants can try to pull in percentages from experts all they want (and they were calling my nuclear weapons arms control friends a year ago asking for percentiles) but it isn't the same thing because the model is still fundamentally concerned with statistics and many of the events we understand as humans have implicit dependence to each other that is hard to model. It's far easier to employ a small number of smart people and have the models serve and be tuned by them than to have the models actually run everything. Plus you don't even really need them sometimes. Take Bitcoin, for example. The gains were obvious. The incentives were completely aligned and the friction was in the buy side and it was temporary. I didn't need to model out Bitcoin to buy it at $4 CAD. I just had to think about it from first principles, something that is currently not possible with ML.
- eldavido 8y ago
  You strike me as someone who has thought very deeply about this. I think of it as being too much context. There is just way too much real-world context for computers to assimilate. We humans might be terrible at understanding things like abstract algebra but evolution has left us with pretty well-optimized systems for understanding social cues, complex behavioral networks, and other nuance of human behavior. I completely agree with your thesis.
  - 3pt14159 8y ago
    Thank you David—kind comments like this mean much to me. Your Github activity seems like it's on a bit of a break. Are you on holiday or are you looking for something new?
viburnum 8y ago
He's right, we don't need finance or rich people to run the economy. Bring on the fully automated luxury communism!
rootusrootus 8y ago
Interesting. When I click on the article, this is not the headline I see. I get "Are Index Funds Communist?" with a byline of "There won't be much left to do once the investment robots perfect capitalism." If it were meant as clickbait, the communist headline would be better :)
- dang 8y ago
  The HN guidelines ask for titles to be changed when they're misleading or clickbait (https://news.ycombinator.com/newsguidelines.html https://news.ycombinator.com/newsguidelines.html). This one was the latter. Please see https://news.ycombinator.com/item?id=18144886 https://news.ycombinator.com/item?id=18144886 for more explanation.
anonu 8y ago
This is a common refrain. Passive indexing is killing the market. ETFs are killing the market. I take a very cyclical approach on everything. The rise of passive actually creates huge opportunities for active managers. We see this already in the ETF landscape: you can invest in any product today for very cheap. This creates a new challenge to manage the portfolio of the future. 60/40 allocations are the exposures of yesterday.
Xixi 8y ago
A pet theory of mine: if everybody starts investing in passive funds replicating indexes, then the creativity will go into increasingly more sophisticated indexes. You might for instance want to make the bet that the market at large is systematically underestimating the risks related to global warming in particular, and the environment in general. Said differently, it is entirely possible that governments will start to tax the hell out of various externalities, like CO2 emissions, or plastic garbage generation. Or maybe courts will ask companies to pay to clean up after their own mess. If you believe that this is true, then indexes (existing or being created) weighting in those risks will over-perform the S&P 500 in the medium term, until a couple of companies are wiped out and analysts start to correctly price in these risks... That's just one example of the kind of creative index that could be created.
- tryptophan 8y ago
  In some ways this this already happening with the whole "smart beta" thing, based on academic research on different "factor" classes of stocks.
- ndesaulniers 8y ago
  A "creative index" is another term for a "fund."
  - pmart123 8y ago
    I disagree with your definition strongly. An investment portfolio at the end of the day is just a collection of securities, and an index is a frictionless way to measure and evaluate a collection of securities, typically to a predefined methodology. You could run a S&P 500 like separately managed account to replicate a passive index, and this would have nothing to do with being invested in a fund. Meanwhile, Yoi could create a commingled fund, mutual fund, or active ETF that has no index.
    - throwawaymath 8y ago
      The commenter's point is that the "predefined methodology" can be indistinguishable from active investing if it's sufficiently complex and frequent. It starts getting pretty silly to call it passive. Otherwise an active investor could simply codify their entire investing methodology into an algorithm and start following it passively, then declare that they're just adhering to a very complex index. But quantitative investors are still active investors. If you take a widely accepted, reasonably broad market definition and an index to track it (such as the S&P 500 for equities), then sure, you're investing passively. The portfolio reallocation and equity inclusion happens according to rules which organically rise from the market definition itself. But you can creatively define a market for any kind of security and then an index methodology for tracking that market which may involve a complicated set of inclusion rules that are arguably just active investing. This is something Matt Levine has talked about in his column on a number of occasions - some active investors are now rebranding their funds as index funds for creative, synthetic indices. The practical distinction between beta and "smart beta" is a lot larger than the distinction between "smart beta" and alpha, regardless of philosophical underpinnings.
Latteland 8y ago
I have thought for a while that most of the financial advisers are just middlemen on the stock market, getting a small amount of my money by trading for me. If I just buy index funds I'll do fine. My financial adviser who charges me at 0.75% management fee didn't protect me from huge losses in 2008 and 2009. I don't necessarily blame her, but she was not really different than buying an index fund or a managed year retirement fund.
- jypepin 8y ago
  Exactly. The Little Book of Common Sense Investing is a very nice read on that matter.
  - bootsz 8y ago
    "A Random Walk Down Wall Street" is another good one. Doesn't take much reading/investigation to figure out how bad of a deal most investment "management" services are, at least for the average person. It's not too unlike a casino: in the long run the house always wins. You're not the house.
    - jypepin 8y ago
      Indeed. It's in my kindle and will get to reading it asap!
njarboe 8y ago
Since the public stock market is no longer a place where companies sell stock to raise capital to build things to make even more capital (Tesla excepted), is seems unproductive to give people who can do well in a prediction market of the future cash flow of public companies (the stock market, basically) lots of resources for doing that. It would be cooler and more useful if we supported prediction markets in all kinds of things that people want to know about. The average yearly temperature at 50 known recording stations in Europe from 2020-2030, 2030-2040, 2040,2050, 2060-2070, etc., would be one many governments, corporations, and people would like to know about.
- atomical 8y ago
  Prediction markets are more hype than substance. The future can't be predicted through gambling.
  - fjsolwmv 8y ago
    The stock market is a prediction market.
asdfasgasdgasdg 8y ago
HN title doesn't match article title, and in fact cites a thesis that the article disagrees with.
- dang 8y ago
  We changed the title, in keeping with the site guidelines: "Please use the original title, unless it is misleading or linkbait." Please see https://news.ycombinator.com/item?id=18144886 https://news.ycombinator.com/item?id=18144886 for more explanation. I'll add a question mark to indicate that agreement isn't implied. If you can suggest a better (i.e. more accurate and neutral) title, preferably using representative language from the article, we'll happily change it.
arikrak 8y ago
I'm not sure what the concern is with index funds. For now they're a better deal than active funds but if they take over too much of the market that will leave more opportunities for active investors to succeed.
forkLding 8y ago
The issue is that in the long run, index funds or passive investors do outperform hedge funds or active investment management as shown by Warren Buffett: https://www.cnbc.com/2018/02/16/warren-buffett-won-2-point-2-million-on-a-bet-and-gave-it-to-girls-inc.html https://www.cnbc.com/2018/02/16/warren-buffett-won-2-point-2... There are a lot of factors at play but simply for your non-analyst mom-and-pop investors, they don't have time and the know-how to investigate stocks and index funds are just much more accessible and as they say, in the long run we are all dead.
- CryptoPunk 8y ago
  This is true right now, but it's situational, not a constant that is guaranteed to remain unchanged. If passive investments continue growing as a percentage of all investment capital, they will eventually underperform actively managed investments because market prices will cease to be reflective of value.
  - C1sc0cat 8y ago
    This is happening all ready for example one of my active investments saw the bank crash coming and mostly sold out of banks before the crash. Then again this IT was started in 1888 and has increased its dividend every year for the last 51 years.
- throwawaymath 8y ago
  Nitpick: it would be more correct and precise to say that index funds tracking the total market beat the average aggregate performance of hedge funds on a long enough timeline. In practice that timeline tends to be quite short in the current market climate. I mention this because (regardless of your intention in particular) Warren Buffett's famous bet is extremely overused and cited as evidence for many claims it doesn't really support. Someone's takeaway from your comment could be that all hedge funds fail to beat the market - but that's not even what Warren Buffett believes (Buffett doesn't believe in the efficient market hypothesis). This is to say that index funds are generally a superior investment vehicle for modal investors. But that shouldn't be used to extrapolate broader truths about active versus passive management, except that active management is a lot harder. An (imperfect) analogy I like to use is that of a kid whose dream is to get drafted into the NBA. You'd probably tell them to have a solid backup plan for a more realistic way to make a living, because approximately no one is drafted into the NBA. Vastly more people try and fail than are actually drafted. But that doesn't tell us the NBA is itself a fiction. Similar parallels exist in venture capital investment, startup success, acting and making music.
kaycebasques 8y ago
Theoretically, I think the concern is reasonable. The "concern" here being if everyone switches to passive funds, then the behavior of markets will change. However, when you look at the numbers, it doesn't seem like this concern is actually a reality. > The market capitalization of the S&P 500 is roughly $22 trillion as I write this. The entire ETF market in the U.S. is $3 trillion. That’s 14%. Even the whole industry—about $4 trillion, would only be 18%. https://www.etf.com/sections/blog/no-etfs-dont-own-37-sp-500 https://www.etf.com/sections/blog/no-etfs-dont-own-37-sp-500 This statistic was actually a big wake up call for me about 6 months ago. For a long time I had been investing based on theoretical ideas, like the one mentioned in this Bloomberg article that we're discussing. After I saw this statistic, I realized that I needed to look closer at the numerical reality when making investing decisions. This is probably obvious to many of you. I'm just sharing the moment when this insight really hit home for me.
- deleted 8y ago
  [deleted]
- pfortuny 8y ago
  Right, the concern is true. However, when that happens, arbitrage opportunities arise elsewhere (based on that correlation). As a matter of fact, one can start "betting" on the correlation being high and the only way for the "opponent" to win is to dislodge that correlation. In the end: technical analysis is useless by definition.
  - akvadrako 8y ago
    It's useless if other people are doing it too, but if you are ahead of the curve there should be money to be made.
- pgwhalen 8y ago
  ETFs may be associated with passive investing, but there is passive investing without ETFs, and active investing using ETFs.
  - 8y ago
jypepin 8y ago
> Indexing is cheaper, yes, but that's because active management has positive externalities, and if no one will pay for it, those benefits will disappear. Oh yeah? which benefits? When you know that on average, an astonishing 90 percent of actively managed mutual funds underperformed their benchmark indexes over the preceding 15 years. The index superiority was consistent and overwhelming. I recently read the Little Book Of Common Sense Investing, and it was brilliant.
- a008t 8y ago
  If nobody is actually analyzing the companies to discover their intrinsic value, stock prices will detach from fundamentals and we will see much bigger crashes than we ever saw before.
- throwawaymath 8y ago
  > Oh yeah? which benefits? Price discovery. Price discovery is directly facilitated by trading. The more frequent the trading, the more efficient the pricing mechanism (all else being equal). Active trading also facilitates higher liquidity. Neither of these things can be properly facilitated by a passive index. Buying and selling (bidding and asking) is a mechanism for expressing optimistic and pessimistic sentiment about an asset's price. The only thing a passive index can convey is neutral sentiment, because it's just holding. For a specific example of why this is important, let's look at something slightly different. Indices are only capable of expressing neutral sentiment in a market. It lacks the buying and selling functions. But private equity - such as venture capital investing, likewise lacks certain price discovery functions that public markets have. Private companies cannot be directly shorted regardless of how large their valuation. Likewise since liquidity is low it's easier to buy more shares than it is to sell shares. This naturally leads to a positive pressure on the pricing mechanism, resulting in inflated valuations that don't take into account pessimism. Regardless of whether or not you feel tech is in a bubble, this is one reason why tech valuations have skyrocketed. There are credible arguments that similar distortions could happen to public markets if passive indices capture the vast majority of investing. But that's by no means a certainty.
jayalpha 8y ago
Passive funds were never meant to be used on this scale. I don't have time to explain it to you, but this post outlines the problems with passive ETF pretty well: http://www.zerohedge.com/news/2017-04-09/horseman-global-unveils-new-shorting-philosophy-using-etf-flows-catalyst http://www.zerohedge.com/news/2017-04-09/horseman-global-unv...
- zazen 8y ago
  > I don't have time to explain it to you Just read that phrase again and think about how it comes across.
  - jayalpha 8y ago
    I give a fuck. Look, I have to work sometimes too. The post (yes, Zerohedge is not a great source) explains it quite well. If someone does not understand the problem after reading it, he maybe should ask himself if it is a good idea to be invested in the stock market. So, take it or leave it. Stop bitching.
atemerev 8y ago
The only driving force for the popularity of passive investing is the bull market of the past 10 years. It will be significantly less popular when we hit the next recession.
- gruez 8y ago
  care to give your reasoning for both of those claims?
- fjsolwmv 8y ago
  That's not true if actively managed funds fail as bad or worse during a bear market.
osullivj 8y ago
There's a phrase we use in investment banking: "talking his own book." A trader is talking their own book when the superficially neutral view they give of the market is designed to promote the value of their own positions. The active managers that Levine quotes are talking their own books when they decry passive funds. As ever, one should follow the money, and ask who stands to benefit if a view of recommendation is implemented. "Where are the customers yachts?"
jondubois 8y ago
The worst part is that many governments around the world use peoples' Superannuation/401k accounts to invest in index funds. In Australia, employee contributions of 12% are mandatory... So basically the government is driving inequality and centralization of wealth using people's own money. This represents an unfathomable about of money
- danieltillett 8y ago
  You can run a SMSF here in Australia if you want to make your own investment decisions.
  - jondubois 8y ago
    Yes but from what I remember it wasn't that easy to do. When opting out is so difficult, most people will just stick to the default. This kind of approach is bound to increase centralization of wealth.
    - danieltillett 8y ago
      It is not super difficult (sorry for the pun), but it can be time consuming and only really worth doing if you have more than $250,000. At least we have a choice.
PaulHoule 8y ago
Back when hedgies were the masters of the universe and every punk and his dog was starting a hedge fund and when you could beat treasury bills with "market neutral" strategies people used to blame correlation on hedgies.
dwighttk 8y ago
Is a wag's take on this "Idiots no longer wasting as much money betting on long shots that are longer than they thought" ?
avyfain 8y ago
The seminal paper on this topic seems to be Anticompetitive Effects of Common Ownership[0] by Azar et al, and there's a whole chapter on this topic in Radical Markets[1], a recent book by Eric Posner and Glen Weyl. Both are worth reading if this is a topic you're interested in. [0] https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2427345 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2427345 [1] https://www.amazon.com/Radical-Markets-Uprooting-Capitalism-Democracy/dp/0691177503/ https://www.amazon.com/Radical-Markets-Uprooting-Capitalism-...

178 points by abhi3 8y ago

mr_toad 8y ago

Is Bloomberg a tabloid? The answer may shock you!

analog31 8y ago
That depends on how you fold a website. ;-)

dang 8y ago

The article is interesting. We replaced the baity title with representative language from the text. Hopefully that will spare us all yet another boring flamewar about the c-word. If anyone can suggest a more accurate and neutral title, we can change it again. Edit: ok, you guys didn't like "When analysts are replaced with index funds, the market stops allocating capital", so I dug up another representative sentence from the article. The best way to complain about a title is to offer a better one, so if you don't like this one either, maybe take a crack at it?

deleted 8y ago
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tanderson92 8y ago
The "index funds" thing is throwing people off the track of the article, which is more about robots than index funds proper. Perhaps "when human analysts are replaced with algorithmic robots, capital markets will feature less activity but what about efficiency?".
- dang 8y ago
  It needs to be 80 chars or less.
loeg 8y ago
The replacement text is worse — it's still baity in the same way, but differs arbitrarily from the headline.
- dang 8y ago
  That's why I asked for help with a replacement. The article's headline breaks the site guidelines (https://news.ycombinator.com/newsguidelines.html https://news.ycombinator.com/newsguidelines.html), so obviously we can't keep that one.

PopePompus 8y ago

This article brings up a point I used to worry about - if people are just automatically pumping money into a list of stocks, how does the price remain connected to reality?. But apparently the answer is that mis-priced stocks present an arbitrage opportunity (https://www.investopedia.com/terms/i/indexarbitrage.asp https://www.investopedia.com/terms/i/indexarbitrage.asp), so as long as a few people are paying attention, the price remains rational, and the remaining people paying attention are rewarded for doing so. The Economist had an article about this issue recently and they concluded that the main effect of Index Funds was to drive low-performance fund managers out of business.

deleted 8y ago
[deleted]
prostoalex 8y ago
To quote somebody I heard on a Goldman Sachs podcast, "When everyone is seeking alpha, there's money to be made in beta, and vice versa".
erik_seaberg 8y ago
When $3B net income isn't an obstacle to a $1T market cap, reality is sort of optional.
- akvadrako 8y ago
  I assume you are talking about Amazon. Who cares about past income? What matters is future earnings and it's clear they have lots of earnings potential.
  - sinsterizme 8y ago
    Yeah they do. But a $1T valuation implies a crazy amount of cash flow growth. They're top-line is increasing at 20%-30% per year right now but how long can that continue
dustingetz 8y ago

djrogers 8y ago

The conclusions here seem to be based on a) a purely passive market, and b) a static amount of capital. I’d like to see an analysis that offsets the potential inefficiency of a partially passive market with the gains to the economy from additional capital being available to invest. Are we better or worse off with a market that is n% less efficient, but that has y% more capital from passive investors than a purely active market would have?

jameslk 8y ago

Once they've found the perfect capital allocation algorithm to replace markets, they can work on the perfect policy calculating algorithm to replace democracy Edit: /s

UncleEntity 8y ago
I think they will never find the perfect capital allocation algorithm or solve the economic calculation problem. There's just too many self-interested market actors to possibly be able to predict what their future wants will be to throw out the function that the entrepreneur provides, those who predict future wants correctly make money and those who don't lose their investment. Unless, of course, all they want is a static model of current consumption at the expense of human progress.
- jameslk 8y ago
  I'd be more concerned about the potential conflict of interest having such algorithms control major functions of other's lives. My post was meant to be sarcastic, however I'm getting a lot of downvotes, so perhaps the sarcasm wasn't clear.

ISL 8y ago

To me, the interesting question is: if the market is mostly index funds, what does that do? Lots of passive money means that the market is an amplifier for the decisions of those who choose to make their own decisions. Want $AMZN to have a little more market capitalization? Buy some, and the entire market is forced to follow you. Sell some, and they will follow you, too. It is herd behavior (which can be quite beneficial), but it affords certain advantages to those wily enough to use the herd instinct for their own designs.

ucaetano 8y ago
> To me, the interesting question is: if the market is mostly index funds, what does that do? This will never happen. It might be interesting, but isn't a realistic scenario.
- prostoalex 8y ago
  Why?
  - ucaetano 8y ago
    I posted it here: https://news.ycombinator.com/item?id=18145067 https://news.ycombinator.com/item?id=18145067 But essentially, as % of market on index funds increases, the returns on arbitrage-seeking actively managed portfolios will increase (vs. the market) to the point that they provide higher returns than the index funds (due to index funds no longer accurately capturing all information available in the market), resulting in a shift of money out of index funds to active funds, decreasing the returns in active funds and keeping the market in equilibrium.
brisance 8y ago
The "you" refers to the "index fund manager", yes? If so, then your thesis doesn't make sense. The index fund manager's job is to maintain the fund's allocation according to the index calculation to the best of his ability, not "go out and buy some $AMZN cos it looks cheap" (which opens up the fund for civil lawsuits for not adhering to the prospectus), or to "manipulate the herd". Tracking errors happen, but those are incidental to the need for re-balancing and are not outright actions undertaken by the fund manager for the purposes stated above.

jorblumesea 8y ago

If you went to a financial advisor 30 years ago, they would have said "give me your money and I'll make you a portfolio". He/she would then have bought most of the S&P 500 or some other exchange in a diversified manner buying equities and bonds. They would have shifted around your allocations ever so slightly every quarter, buying some stocks and selling others. But really, the strategy was to buy and hold. Bonds were similar. Is that not indexing under another name?

kgwgk 8y ago
He would not buy “most of the s&p 500”. He would pick stocks to (try to) do better than the s&p 500. Indexing was not common 30 years ago. http://s18674.pcdn.co/wp-content/uploads/2015/05/Index-market-share.jpg http://s18674.pcdn.co/wp-content/uploads/2015/05/Index-marke...
- jorblumesea 8y ago
  Indexing was very common, it just wasn't called indexing. It was called "active investing" but the reality is it wasn't as active or as smart as people think it was. It was very similar to today's indexing where you would funnel your money into the Facebook, Google, Amazon's of the day and collect a fat fee. This is how index funds work today, when you invest in a S&P 500 index fund it's really weighted towards the huge hitters. The dirty secret of active investing is every active investor had some kind of index-like fund going that constituted a large percentage of their portfolio. That graph is precisely my point, it's all about how we're measuring what it means to be an "index". You could engage in index-like behavior but be an "active investor". Indexing is just a label.
  - kgwgk 8y ago
    Of course the market as a whole has been always indexing by mathematical necessity. Indexing is just a label, true, but it happens to be the label applied to investing exactly in proportion to the weight of each stock in the index. As opossed to "active investing".

wmnwmn 8y ago

The market already doesn't allocate capital. Companies almost never issue new shares, indeed they buy them back. Given that dividends are also trifling, the market is mainly a large scale gambling scheme. Not entirely, but mainly.

koboll 8y ago
That's why I love index funds. You're betting with the house, not against it.
khuey 8y ago
Companies issue new shares all the time. Tech company stock buyback programs are often treading water against employee equity compensation.

sysk 8y ago

> The function of the capital markets is to allocate capital. I never fully grasped this idea. I have no problem understanding that venture capitalists, angel investors or investors that buy shares at IPO do allocate capital. However, why is trading existing shares considered "allocating capital"?

tedsanders 8y ago
Every purchase of a share rewards the previous owner with some cash. Follow that chain of trades backward and eventually you end up rewarding the founder, the early employees, the VCs, etc. It's a long, tenuous chain, but it's there. I agree with the general point that most trades of mature companies don't seem to have a material effect on the expectations of today's founders, early employees, VCs, etc. Though in theory if liquidity dried up enough or valuations fell, those signals would noisily backpropagate through prices and shift expectations of rewards.
- sysk 8y ago
  I understand the concept of liquidity and the reward mechanism you describe but it doesn't ultimately answer my question, which why is the process of buying an existing share called "capital allocation"? Let's say I buy a GOOG share from Larry Page. Is it the idea that I "allocated capital" to Larry Page's bank account? It seems to me like the correct thing to say would be that I provided liquidity to Larry, not that I allocated capital. Or is it the idea that I allocated some of my own capital to the stock market?
  - roenxi 8y ago
    Two points, one going to your question and one is of general interest. Buying existing shares is "capital allocation" with respect to the _buyer's capital_. So I might allocate 20% of my capital (ie, gross financial worth) to being in shares of some company. The seller is allocating their capital somewhere other than the share. So you allocate your capital to GOOG, pay Larry and notify Alphabet that you are one of their capitalist overlords. If the price of Alphabet stock goes up, you now have more capital even though if you do a quick count you'll discover you have no new currency/cash. The reason this is important is that the people with a good ability to allocate capital will end up with more capital hence control. Eventually, the people in charge will be the people with a good grasp of what is changing (which I'll claim is desirable with no support). For general interest, I've no insight into the intricacies of the US system, but in Australia every so often a company creates and sells new shares directly on the market. The upshot of this is a company can access the market directly for capital.

ucaetano 8y ago

This is fearmongering. If the market approached an allocation to index funds that enabled arbitrage, more actors would switch to arbitrage eliminating such arbitrage. It is a self-balancing situation. A scenario of "oh my god, everyone is just putting their money on index funds" would never happen. Another way to think about it is in terms of evolutionary stable strategy. Index funds and arbitrage-seeking reach a Nash equilibrium at some point (far more index-allocated than today's market) where arbitrage-seekers will reap returns almost equal to index funds, as index allocation starts o not capture all available market information. If the market deviates from that point, forces push it back into that point. If the market starts over-allocating into arbitrage-seeking (like today), returns on index funds will beat arbitrage, pushing capital back into index funds. If the market over-allocates in index funds, index funds will return below arbitrage, pushing money out of index funds. Edit: Right now, the market is still far over-allocated into the arbitrage-seeking side, resulting in a natural shift to index funds.

prostoalex 8y ago
To initiate a transaction an arbitrageur, though, needs a counter-party that's also engaged in arbitraging, but has an opposite opinion. Thought experiment - let's say there's an imaginary country that has 100 companies listed publicly, each floating 1,000 shares. Most citizens prefer indexing so 99,000 shares are owned by a bunch of Country 100 index funds. Those index funds will only trade on inflow/outflow into their own fund, never on corporate earnings, board changes, product announcements or other external event. What opportunities are there for arbitrageurs?
- darawk 8y ago
  Someone has to sell to them when they get inflow and buy from them when they get outflow. Who do you think that will be?
  - fjsolwmv 8y ago
    That would be wage savers buying from retirees who are cashing out, both with market orders, not limit orders.

blazespin 8y ago

The biggest danger of all this money in index funds is that the market becomes to big to fail and the government has to keep propping it up. In fact, it becomes a way to actually disburse wealth - enact policies such that they go to people in the market.

fma 8y ago
China did that in 2015 when stock were tanking. "...forced state-owned brokers to promise to buy stocks until the index reached a higher level, mobilized state-controlled funds to purchase equities, and promised unlimited support from the central bank. " https://www.brookings.edu/opinions/making-sense-of-chinas-stock-market-mess/ https://www.brookings.edu/opinions/making-sense-of-chinas-st...
- C1sc0cat 8y ago
  They tried that in 1929 with the Great Crash - it didn't work long-term.
lotsofpulp 8y ago
It’s not index funds that cause the market to be too big to fail. Pension fund investments and 401k investments also go to the same place, index funds just take out the middle man and reduce costs. And yes, that’s why you should be long on mid-large cap equity indexes, because they will always get bailed out, since too many voters are too invested in them. Either more money will be printed or cash infusion or loans from taxpayer, but in any case, the biggest sectors will never fail completely as they will always be re-inflated (in the US, as long as its currency and military continue to have the most power).

darawk 8y ago

This narrative is such a joke, and such a profound misunderstanding of economics i'm surprised Bloomberg would publish it. Simple rule: if your argument implies that there is or will be free money to be made in the stock market, your argument is probably wrong.

Terr_ 8y ago

This is equivalent to worrying that all the animals in the entire world might eventually become helpless herbivores. Relevant past topic: https://news.ycombinator.com/item?id=12368136 https://news.ycombinator.com/item?id=12368136

3pt14159 8y ago

It's actually a great article with a HN title that misrepresents what it is actually about. Anyway, with that proviso, here is my take: So long as the bots aren't conscious there will be no bot-dominated stock market. Too much information is wrapped up in conscious thought that isn't easily expressed in stock market pattern matching. The article mentions that the line between active and passive isn't as clear as people that make it out to be say it is, and that is true, but it's also incomplete. Certain events are conceivable to humans that are not conceivable to machines. Short of simulating humans, anyway. For example, I as a human know that there is a non-zero chance that the DPRK and USA get into a nuclear war. I can know that Trump defaulting on Chinese held US debt is something that is at least on the table. The quants can try to pull in percentages from experts all they want (and they were calling my nuclear weapons arms control friends a year ago asking for percentiles) but it isn't the same thing because the model is still fundamentally concerned with statistics and many of the events we understand as humans have implicit dependence to each other that is hard to model. It's far easier to employ a small number of smart people and have the models serve and be tuned by them than to have the models actually run everything. Plus you don't even really need them sometimes. Take Bitcoin, for example. The gains were obvious. The incentives were completely aligned and the friction was in the buy side and it was temporary. I didn't need to model out Bitcoin to buy it at $4 CAD. I just had to think about it from first principles, something that is currently not possible with ML.

eldavido 8y ago
You strike me as someone who has thought very deeply about this. I think of it as being too much context. There is just way too much real-world context for computers to assimilate. We humans might be terrible at understanding things like abstract algebra but evolution has left us with pretty well-optimized systems for understanding social cues, complex behavioral networks, and other nuance of human behavior. I completely agree with your thesis.
- 3pt14159 8y ago
  Thank you David—kind comments like this mean much to me. Your Github activity seems like it's on a bit of a break. Are you on holiday or are you looking for something new?

viburnum 8y ago

He's right, we don't need finance or rich people to run the economy. Bring on the fully automated luxury communism!

rootusrootus 8y ago

Interesting. When I click on the article, this is not the headline I see. I get "Are Index Funds Communist?" with a byline of "There won't be much left to do once the investment robots perfect capitalism." If it were meant as clickbait, the communist headline would be better :)

dang 8y ago
The HN guidelines ask for titles to be changed when they're misleading or clickbait (https://news.ycombinator.com/newsguidelines.html https://news.ycombinator.com/newsguidelines.html). This one was the latter. Please see https://news.ycombinator.com/item?id=18144886 https://news.ycombinator.com/item?id=18144886 for more explanation.

anonu 8y ago

This is a common refrain. Passive indexing is killing the market. ETFs are killing the market. I take a very cyclical approach on everything. The rise of passive actually creates huge opportunities for active managers. We see this already in the ETF landscape: you can invest in any product today for very cheap. This creates a new challenge to manage the portfolio of the future. 60/40 allocations are the exposures of yesterday.

Xixi 8y ago

A pet theory of mine: if everybody starts investing in passive funds replicating indexes, then the creativity will go into increasingly more sophisticated indexes. You might for instance want to make the bet that the market at large is systematically underestimating the risks related to global warming in particular, and the environment in general. Said differently, it is entirely possible that governments will start to tax the hell out of various externalities, like CO2 emissions, or plastic garbage generation. Or maybe courts will ask companies to pay to clean up after their own mess. If you believe that this is true, then indexes (existing or being created) weighting in those risks will over-perform the S&P 500 in the medium term, until a couple of companies are wiped out and analysts start to correctly price in these risks... That's just one example of the kind of creative index that could be created.

tryptophan 8y ago
In some ways this this already happening with the whole "smart beta" thing, based on academic research on different "factor" classes of stocks.
ndesaulniers 8y ago
A "creative index" is another term for a "fund."
- pmart123 8y ago
  I disagree with your definition strongly. An investment portfolio at the end of the day is just a collection of securities, and an index is a frictionless way to measure and evaluate a collection of securities, typically to a predefined methodology. You could run a S&P 500 like separately managed account to replicate a passive index, and this would have nothing to do with being invested in a fund. Meanwhile, Yoi could create a commingled fund, mutual fund, or active ETF that has no index.
  - throwawaymath 8y ago
    The commenter's point is that the "predefined methodology" can be indistinguishable from active investing if it's sufficiently complex and frequent. It starts getting pretty silly to call it passive. Otherwise an active investor could simply codify their entire investing methodology into an algorithm and start following it passively, then declare that they're just adhering to a very complex index. But quantitative investors are still active investors. If you take a widely accepted, reasonably broad market definition and an index to track it (such as the S&P 500 for equities), then sure, you're investing passively. The portfolio reallocation and equity inclusion happens according to rules which organically rise from the market definition itself. But you can creatively define a market for any kind of security and then an index methodology for tracking that market which may involve a complicated set of inclusion rules that are arguably just active investing. This is something Matt Levine has talked about in his column on a number of occasions - some active investors are now rebranding their funds as index funds for creative, synthetic indices. The practical distinction between beta and "smart beta" is a lot larger than the distinction between "smart beta" and alpha, regardless of philosophical underpinnings.

Latteland 8y ago

I have thought for a while that most of the financial advisers are just middlemen on the stock market, getting a small amount of my money by trading for me. If I just buy index funds I'll do fine. My financial adviser who charges me at 0.75% management fee didn't protect me from huge losses in 2008 and 2009. I don't necessarily blame her, but she was not really different than buying an index fund or a managed year retirement fund.

jypepin 8y ago
Exactly. The Little Book of Common Sense Investing is a very nice read on that matter.
- bootsz 8y ago
  "A Random Walk Down Wall Street" is another good one. Doesn't take much reading/investigation to figure out how bad of a deal most investment "management" services are, at least for the average person. It's not too unlike a casino: in the long run the house always wins. You're not the house.
  - jypepin 8y ago
    Indeed. It's in my kindle and will get to reading it asap!

njarboe 8y ago

Since the public stock market is no longer a place where companies sell stock to raise capital to build things to make even more capital (Tesla excepted), is seems unproductive to give people who can do well in a prediction market of the future cash flow of public companies (the stock market, basically) lots of resources for doing that. It would be cooler and more useful if we supported prediction markets in all kinds of things that people want to know about. The average yearly temperature at 50 known recording stations in Europe from 2020-2030, 2030-2040, 2040,2050, 2060-2070, etc., would be one many governments, corporations, and people would like to know about.

atomical 8y ago
Prediction markets are more hype than substance. The future can't be predicted through gambling.
- fjsolwmv 8y ago
  The stock market is a prediction market.

asdfasgasdgasdg 8y ago

HN title doesn't match article title, and in fact cites a thesis that the article disagrees with.

dang 8y ago
We changed the title, in keeping with the site guidelines: "Please use the original title, unless it is misleading or linkbait." Please see https://news.ycombinator.com/item?id=18144886 https://news.ycombinator.com/item?id=18144886 for more explanation. I'll add a question mark to indicate that agreement isn't implied. If you can suggest a better (i.e. more accurate and neutral) title, preferably using representative language from the article, we'll happily change it.

arikrak 8y ago

I'm not sure what the concern is with index funds. For now they're a better deal than active funds but if they take over too much of the market that will leave more opportunities for active investors to succeed.

forkLding 8y ago

The issue is that in the long run, index funds or passive investors do outperform hedge funds or active investment management as shown by Warren Buffett: https://www.cnbc.com/2018/02/16/warren-buffett-won-2-point-2-million-on-a-bet-and-gave-it-to-girls-inc.html https://www.cnbc.com/2018/02/16/warren-buffett-won-2-point-2... There are a lot of factors at play but simply for your non-analyst mom-and-pop investors, they don't have time and the know-how to investigate stocks and index funds are just much more accessible and as they say, in the long run we are all dead.

CryptoPunk 8y ago
This is true right now, but it's situational, not a constant that is guaranteed to remain unchanged. If passive investments continue growing as a percentage of all investment capital, they will eventually underperform actively managed investments because market prices will cease to be reflective of value.
- C1sc0cat 8y ago
  This is happening all ready for example one of my active investments saw the bank crash coming and mostly sold out of banks before the crash. Then again this IT was started in 1888 and has increased its dividend every year for the last 51 years.
throwawaymath 8y ago
Nitpick: it would be more correct and precise to say that index funds tracking the total market beat the average aggregate performance of hedge funds on a long enough timeline. In practice that timeline tends to be quite short in the current market climate. I mention this because (regardless of your intention in particular) Warren Buffett's famous bet is extremely overused and cited as evidence for many claims it doesn't really support. Someone's takeaway from your comment could be that all hedge funds fail to beat the market - but that's not even what Warren Buffett believes (Buffett doesn't believe in the efficient market hypothesis). This is to say that index funds are generally a superior investment vehicle for modal investors. But that shouldn't be used to extrapolate broader truths about active versus passive management, except that active management is a lot harder. An (imperfect) analogy I like to use is that of a kid whose dream is to get drafted into the NBA. You'd probably tell them to have a solid backup plan for a more realistic way to make a living, because approximately no one is drafted into the NBA. Vastly more people try and fail than are actually drafted. But that doesn't tell us the NBA is itself a fiction. Similar parallels exist in venture capital investment, startup success, acting and making music.

kaycebasques 8y ago

Theoretically, I think the concern is reasonable. The "concern" here being if everyone switches to passive funds, then the behavior of markets will change. However, when you look at the numbers, it doesn't seem like this concern is actually a reality. > The market capitalization of the S&P 500 is roughly $22 trillion as I write this. The entire ETF market in the U.S. is $3 trillion. That’s 14%. Even the whole industry—about $4 trillion, would only be 18%. https://www.etf.com/sections/blog/no-etfs-dont-own-37-sp-500 https://www.etf.com/sections/blog/no-etfs-dont-own-37-sp-500 This statistic was actually a big wake up call for me about 6 months ago. For a long time I had been investing based on theoretical ideas, like the one mentioned in this Bloomberg article that we're discussing. After I saw this statistic, I realized that I needed to look closer at the numerical reality when making investing decisions. This is probably obvious to many of you. I'm just sharing the moment when this insight really hit home for me.

deleted 8y ago
[deleted]
pfortuny 8y ago
Right, the concern is true. However, when that happens, arbitrage opportunities arise elsewhere (based on that correlation). As a matter of fact, one can start "betting" on the correlation being high and the only way for the "opponent" to win is to dislodge that correlation. In the end: technical analysis is useless by definition.
- akvadrako 8y ago
  It's useless if other people are doing it too, but if you are ahead of the curve there should be money to be made.
pgwhalen 8y ago
ETFs may be associated with passive investing, but there is passive investing without ETFs, and active investing using ETFs.
- 8y ago

jypepin 8y ago

> Indexing is cheaper, yes, but that's because active management has positive externalities, and if no one will pay for it, those benefits will disappear. Oh yeah? which benefits? When you know that on average, an astonishing 90 percent of actively managed mutual funds underperformed their benchmark indexes over the preceding 15 years. The index superiority was consistent and overwhelming. I recently read the Little Book Of Common Sense Investing, and it was brilliant.

a008t 8y ago
If nobody is actually analyzing the companies to discover their intrinsic value, stock prices will detach from fundamentals and we will see much bigger crashes than we ever saw before.
throwawaymath 8y ago
> Oh yeah? which benefits? Price discovery. Price discovery is directly facilitated by trading. The more frequent the trading, the more efficient the pricing mechanism (all else being equal). Active trading also facilitates higher liquidity. Neither of these things can be properly facilitated by a passive index. Buying and selling (bidding and asking) is a mechanism for expressing optimistic and pessimistic sentiment about an asset's price. The only thing a passive index can convey is neutral sentiment, because it's just holding. For a specific example of why this is important, let's look at something slightly different. Indices are only capable of expressing neutral sentiment in a market. It lacks the buying and selling functions. But private equity - such as venture capital investing, likewise lacks certain price discovery functions that public markets have. Private companies cannot be directly shorted regardless of how large their valuation. Likewise since liquidity is low it's easier to buy more shares than it is to sell shares. This naturally leads to a positive pressure on the pricing mechanism, resulting in inflated valuations that don't take into account pessimism. Regardless of whether or not you feel tech is in a bubble, this is one reason why tech valuations have skyrocketed. There are credible arguments that similar distortions could happen to public markets if passive indices capture the vast majority of investing. But that's by no means a certainty.

jayalpha 8y ago

Passive funds were never meant to be used on this scale. I don't have time to explain it to you, but this post outlines the problems with passive ETF pretty well: http://www.zerohedge.com/news/2017-04-09/horseman-global-unveils-new-shorting-philosophy-using-etf-flows-catalyst http://www.zerohedge.com/news/2017-04-09/horseman-global-unv...

zazen 8y ago
> I don't have time to explain it to you Just read that phrase again and think about how it comes across.
- jayalpha 8y ago
  I give a fuck. Look, I have to work sometimes too. The post (yes, Zerohedge is not a great source) explains it quite well. If someone does not understand the problem after reading it, he maybe should ask himself if it is a good idea to be invested in the stock market. So, take it or leave it. Stop bitching.

atemerev 8y ago

The only driving force for the popularity of passive investing is the bull market of the past 10 years. It will be significantly less popular when we hit the next recession.

gruez 8y ago
care to give your reasoning for both of those claims?
fjsolwmv 8y ago
That's not true if actively managed funds fail as bad or worse during a bear market.

osullivj 8y ago

There's a phrase we use in investment banking: "talking his own book." A trader is talking their own book when the superficially neutral view they give of the market is designed to promote the value of their own positions. The active managers that Levine quotes are talking their own books when they decry passive funds. As ever, one should follow the money, and ask who stands to benefit if a view of recommendation is implemented. "Where are the customers yachts?"

jondubois 8y ago

The worst part is that many governments around the world use peoples' Superannuation/401k accounts to invest in index funds. In Australia, employee contributions of 12% are mandatory... So basically the government is driving inequality and centralization of wealth using people's own money. This represents an unfathomable about of money

danieltillett 8y ago
You can run a SMSF here in Australia if you want to make your own investment decisions.
- jondubois 8y ago
  Yes but from what I remember it wasn't that easy to do. When opting out is so difficult, most people will just stick to the default. This kind of approach is bound to increase centralization of wealth.
  - danieltillett 8y ago
    It is not super difficult (sorry for the pun), but it can be time consuming and only really worth doing if you have more than $250,000. At least we have a choice.

PaulHoule 8y ago

Back when hedgies were the masters of the universe and every punk and his dog was starting a hedge fund and when you could beat treasury bills with "market neutral" strategies people used to blame correlation on hedgies.

dwighttk 8y ago

Is a wag's take on this "Idiots no longer wasting as much money betting on long shots that are longer than they thought" ?

avyfain 8y ago

The seminal paper on this topic seems to be Anticompetitive Effects of Common Ownership[0] by Azar et al, and there's a whole chapter on this topic in Radical Markets[1], a recent book by Eric Posner and Glen Weyl. Both are worth reading if this is a topic you're interested in. [0] https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2427345 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2427345 [1] https://www.amazon.com/Radical-Markets-Uprooting-Capitalism-Democracy/dp/0691177503/ https://www.amazon.com/Radical-Markets-Uprooting-Capitalism-...