5 ms·

A pet theory of mine: if everybody starts investing in passive funds replicating indexes, then the creativity will go into increasingly more sophisticated index

by 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.
    - pmart123 8y ago
      >>> A "creative index" is another term for a "fund." I agree with what you are saying, but I'm referring to the previous commenter conflating that a "creative index" or passive investing strategy is a fund, or needs to be implemented through a fund structure. Smart beta is really just factor investing with very tight constraints around index tracking error. i.e. It's seeking out high beta and low alpha by design, so given it is aiming for some variation in alpha, I think your argument makes sense.
wcoenen 8y ago
Example of an ETF that tracks an index that adjusts weightings based on carbon footprint: https://www.ishares.com/us/products/271054/ishares-msci-acwi-low-carbon-target-etf https://www.ishares.com/us/products/271054/ishares-msci-acwi...

by Xixi 8y ago

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.
  - pmart123 8y ago
    >>> A "creative index" is another term for a "fund." I agree with what you are saying, but I'm referring to the previous commenter conflating that a "creative index" or passive investing strategy is a fund, or needs to be implemented through a fund structure. Smart beta is really just factor investing with very tight constraints around index tracking error. i.e. It's seeking out high beta and low alpha by design, so given it is aiming for some variation in alpha, I think your argument makes sense.

wcoenen 8y ago

Example of an ETF that tracks an index that adjusts weightings based on carbon footprint: https://www.ishares.com/us/products/271054/ishares-msci-acwi-low-carbon-target-etf https://www.ishares.com/us/products/271054/ishares-msci-acwi...