4 ms·

No. And if passive funds cause poor allocation of capital, that will increase the returns of smart active investing - a negative feedback on pure passive inves

No. And if passive funds cause poor allocation of capital, that will increase the returns of smart active investing - a negative feedback on pure passive investing.

TylerE 8y ago
The problem is that the value of the components of the index is heavily tilted by peoples perception of the value of the index, and not the values of the components.
- nradov 8y ago
  Not at all. Arbitrageurs will always trade away such market inefficiencies. Ultimately valuations always converge to DCF, although it can take a while.
  - polskibus 8y ago
    That's very interesting, can you point me to some reading material related to DCF convergence?
- JumpCrisscross 8y ago
  > the value of the components of the index is heavily tilted by peoples perception of the value of the index “In the short run, the market is a voting machine but in the long run, it is a weighing machine” [1]. Dividends don’t care about peoples’ perceptions. Neither do interest payments and other cash-yielding payments. Active investing will always find a way to take advantage of stupid prices. [1] https://www.goodreads.com/quotes/831517-in-the-short-run-the-market-is-a-voting-machine https://www.goodreads.com/quotes/831517-in-the-short-run-the...
jl2718 8y ago
False. Returns on passive investing are a positive feedback loop. Unless the money supply is stable, and then only dividends matter. Right now, they hardly matter at all.
- kbutler 8y ago
  That's a different feedback. If you can allocate capital better than the index through an active investment (that is, you can find investments that give a better return), you will beat the index, so passive investors will want to invest with you instead - a negative feedback to indexing investment.
  - deleted 8y ago
    [deleted]
sfcguyus 8y ago
Wouldn't agree with you because a company that can return a higher rate of return on capital than one that can't get an allocation based on market cap.
- kuhhk 8y ago
  I've read this three times and I think it's an incomplete sentence. No idea what you're trying to say. Could you please clarify?
  - sfcguyus 8y ago
    Sorry about the late reply. Typically with an index fund, imagine a pie of the money. It's split up and invested into companies, but the allocation depends on the market cap of each company relative to the whole pot. This means returns aren't based on the ability of companies to perform it depends on how big they are at the time. The bigger they are the more allocation of capital they get. Say you have a small company with a very high return rate on its investments, it would get a meagre rate of return compared to say Phillip Morris/Altria which has a lower rate of return, but is just big so it gets a bigger allocation. You'd think its Darwinian but it has odd effects because what's big stays big, and it has nothing to do with the ability of the company to perform now, but what it did decades ago.

No. And if passive funds cause poor allocation of capital, that will increase the returns of smart active investing - a negative feedback on pure passive investing.

TylerE 8y ago

The problem is that the value of the components of the index is heavily tilted by peoples perception of the value of the index, and not the values of the components.

nradov 8y ago
Not at all. Arbitrageurs will always trade away such market inefficiencies. Ultimately valuations always converge to DCF, although it can take a while.
- polskibus 8y ago
  That's very interesting, can you point me to some reading material related to DCF convergence?
JumpCrisscross 8y ago
> the value of the components of the index is heavily tilted by peoples perception of the value of the index “In the short run, the market is a voting machine but in the long run, it is a weighing machine” [1]. Dividends don’t care about peoples’ perceptions. Neither do interest payments and other cash-yielding payments. Active investing will always find a way to take advantage of stupid prices. [1] https://www.goodreads.com/quotes/831517-in-the-short-run-the-market-is-a-voting-machine https://www.goodreads.com/quotes/831517-in-the-short-run-the...

jl2718 8y ago

False. Returns on passive investing are a positive feedback loop. Unless the money supply is stable, and then only dividends matter. Right now, they hardly matter at all.

kbutler 8y ago
That's a different feedback. If you can allocate capital better than the index through an active investment (that is, you can find investments that give a better return), you will beat the index, so passive investors will want to invest with you instead - a negative feedback to indexing investment.
- deleted 8y ago
  [deleted]

sfcguyus 8y ago

Wouldn't agree with you because a company that can return a higher rate of return on capital than one that can't get an allocation based on market cap.

kuhhk 8y ago
I've read this three times and I think it's an incomplete sentence. No idea what you're trying to say. Could you please clarify?
- sfcguyus 8y ago
  Sorry about the late reply. Typically with an index fund, imagine a pie of the money. It's split up and invested into companies, but the allocation depends on the market cap of each company relative to the whole pot. This means returns aren't based on the ability of companies to perform it depends on how big they are at the time. The bigger they are the more allocation of capital they get. Say you have a small company with a very high return rate on its investments, it would get a meagre rate of return compared to say Phillip Morris/Altria which has a lower rate of return, but is just big so it gets a bigger allocation. You'd think its Darwinian but it has odd effects because what's big stays big, and it has nothing to do with the ability of the company to perform now, but what it did decades ago.