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Not an economist, but it's obvious to anyone used to thinking in terms of systems that index funds can't work after a certain amount of the money poured into th

Not an economist, but it's obvious to anyone used to thinking in terms of systems that index funds can't work after a certain amount of the money poured into the system is managed by index funds. What's the limit - 30% 40%, 50%, 60%? What's the current level in terms of managed capital? (Edit: https://www.cnbc.com/2019/03/19/passive-investing-now-controls-nearly-half-the-us-stock-market.html https://www.cnbc.com/2019/03/19/passive-investing-now-contro... says 45% for US stock-based funds, half a year ago, so maybe like 48% now) I wonder if the endgame is that index funds won't be allowed to trade on the the stock exchanges? I can't imagine how that would be enforced. "Mr/Mrs/Ms Fund manager, you've been trading too close to the index, we'll be forced to terminate your access to the markets"?

avvt4avaw 7y ago
You only need the marginal investor to be informed, so it's not clear that you couldn't have a much higher percentage of passive investment (say 90%) and only a small amount of active investors who are providing price discovery. The bigger problem is that most passive investments are not really passive - for example, choosing to invest in a "passive" S&P 500 ETF over a "passive" Russell 2000 ETF is an "active" investment choice (preferring large cap over small cap) so valuation errors and bubbles could develop in segments of the market, even if constituents with an index are all fairly valued relative to one another. These valuation errors could sustain for a long period of time, because it takes much more money to correct a valuation error in a huge market segment than it takes to correct a valuation error in an individual stock.
- davidw 7y ago
  This lists 3575 stocks among its holdings, which includes both large and small cap stocks: https://investor.vanguard.com/mutual-funds/profile/overview/VTSAX/portfolio-holdings https://investor.vanguard.com/mutual-funds/profile/overview/...
  - avvt4avaw 7y ago
    Sure, which is why I said that _most_ passive investments are not really passive. Vanguard Total Stock Market is pretty passive, as long as you consider your investment universe to be "US stocks". But even in this case the fund only holds stocks (no bonds or real estate) and only US stocks at that (no international or emerging market exposure).
- groundlogic 7y ago
  Mind explaining the concept of the marginal investor in this context?
deleted 7y ago
[deleted]
javagram 7y ago
https://www.marketwatch.com/story/john-bogle-has-a-warning-for-index-fund-investors-2017-06-01 https://www.marketwatch.com/story/john-bogle-has-a-warning-f... > Bogle pointed out that as indexing increases to a certain point, it opens opportunities for active investors to exploit inefficiencies in the pricing of some stocks. But past that point, wherever it might be — somewhere beyond 75%, in his view — the market could become a dangerous place.
nostromo 7y ago
> index funds can't work after a certain amount of the money poured into the system is managed by index funds That's not true. They'll still function just fine. What will likely change is that they will begin to underperform other strategies, including different types of indexing and active investing. At that point the market will self-correct and simple indexing will fall out of favor.
- groundlogic 7y ago
  Index funds have become successful since they've performed well compared to active investment funds. Why would the active investors suddenly get better at guessing the future?
  - yifanl 7y ago
    Because when enough of the money is in an index fund, you can predict how a large part of the investors are going to invest (using the same algorithms they're using) and adjust based on that.
    - groundlogic 7y ago
      Kinda makes sense. Still, it sounds like a very fragile system. So instead if active fund managers "knowing the market better", we'll get active fund managers, "knowing the passive investor crowd better". This is madness.
      - yifanl 7y ago
        I mean, if the majority of the market is dumb passive index funds, those are one and the same :)
    - jandrese 7y ago
      That's it exactly. If the index funds get so big that they basically are the market, then active investors will have to adjust their view of the market to be effectively just whatever the index funds do. It may be possible that although they can't beat other active investors enough to justify their fees, they can beat a big dumb index fund enough to make their services worthwhile. That remains to be seen however.
TheCoelacanth 7y ago
It should be self-regulating, though. The higher the portion of the market that is passively investing, the easier it should be to beat their returns by actively investing so the more incentive there will be to actively invest.
- toomuchtodo 7y ago
  There’s an equilibrium to be reached, for sure. The market just hasn’t discovered what it is yet.
  - abakker 7y ago
    I am not an economist either, but it seems that there is a danger in assuming there will be an equilibrium. I think it is entirely possible that there won't be one. If there is an equilibrium, it may take a significant price shock to discover where it is. I.e. that equilibrium could be years behind us, and if there is a crash we might never recover the value that our current market assumes is there.
- whatok 7y ago
  Once indexing gets to be a certain size, you run into the "markets irrational longer than you can stay solvent" issue at a much higher level. Active management "correction" doesn't really work if active managers are a much smaller portion of the market or no longer around at all.
  - whatshisface 7y ago
    Holding doesn't change the price: buying moves it up and selling moves it down. An index fund holding 50% of all shares on the market but not trading them would have no influence at all on prices.
    - whatok 7y ago
      Did you mean to reply to my post? I don't see the relevance.
neilk 7y ago
I’m know I’m a dummy when it comes to economics, and an investor in index funds because of that. But it strikes me that index funds are parasitical in a way and depend on price signals from active investors. Some people say that it’s ok, the situation is self-correcting. But what if the smart active money is active in places we can’t see in the public markets? Again, I’m a dummy, but I believe a lot of investment is happening privately these days.
- perardi 7y ago
  You are not a dummy. Over the past 30 years, index funds have outperformed active management, especially when you consider the fees. You are a ”dummy” in the sense you don’t have perfect information awareness on every possibly tailwind or headwind that could impact a particular stock. But everyone is a dummy in that sense.
  - davidw 7y ago
    > But everyone is a dummy in that sense. And even honest people well versed in economics will tell you that they are too.
- fountainofage 7y ago
  Private investment is absolutely where the money is these days. Look at how the media claims an IPO that doesn't pop 30% or more on day one is a "failure." No one who actually contributed to that company's value benefits from that pop, and best case scenario is really to either have the IPO be flat or even go down a little. But those elite that buy their way to the front of the line demand to have that 30% pop for contributing nothing. I'll just point out there's the argument about market makers and underwriting and blah blah blah. If that's such an issue just price that into the underwriter fees to begin with. No reason the public markets should lose out on a 30% gain to people that didn't actually take a risk and invest early in the company, and only intend to hold the stock for 8 hours at most.
whatshisface 7y ago
>but it's obvious to anyone used to thinking in terms of systems that index funds can't work after a certain amount of the money poured into the system is managed by index funds. If you have one trillion dollars invested, and the entire exchange volume is based on me and my friend trading a single share back and forth, everything will still work. It doesn't matter how much you own, because my friend and I are going to want a fair price for that one share in any case. There's no practical limit to how passive things can get before a problem kicks up, as long as a few hedge funds stay in.
- kds3 7y ago
  > entire exchange volume is based on me and my friend trading a single share back and forth, everything will still work You are talking like such a market is extremely liquid (there are enough shares for everyone). I think when a third person enters such a market your example breaks apart. Now you have one person who constantly wants to buy a stock but is unable to do so. Because you and your friend trade at a fair price and index fund does nothing. So he have to buy at an unfair price and rises his bid until index funds kicks in the game.
kccqzy 7y ago
> it's obvious to anyone used to thinking in terms of systems that index funds can't work after a certain amount of the money poured into the system is managed by index funds How so? I can certainly see "lost opportunities" where good stocks are undervalued just because they aren't in the index funds, but I don't understand why you think index funds can't work. Can you elaborate?
jldugger 7y ago
> What's the limit - 30% 40%, 50%, 60%? I'd wager at least 90 percent. Passive investing is generally designed to track active investor activity without effort, so it shouldn't add much inertia to the system. If Dave thinks IBM is overvalued and Under Armor is overvalued, the act of buying and selling will shift those numbers, and the index investors, instead of taking the opposite trade and undoing that flow of information, hold their portfolio. IMO, the real challenge is active investors competing for access to that 10 percent of active invested money. There's no shortage of people happy to manage money under the 'heads I win, tails you lose' fee structure, and one hopes that the same people fighting over a smaller pool of cash would (more strongly than status quo) favor people who can actually produce results.

avvt4avaw 7y ago

You only need the marginal investor to be informed, so it's not clear that you couldn't have a much higher percentage of passive investment (say 90%) and only a small amount of active investors who are providing price discovery. The bigger problem is that most passive investments are not really passive - for example, choosing to invest in a "passive" S&P 500 ETF over a "passive" Russell 2000 ETF is an "active" investment choice (preferring large cap over small cap) so valuation errors and bubbles could develop in segments of the market, even if constituents with an index are all fairly valued relative to one another. These valuation errors could sustain for a long period of time, because it takes much more money to correct a valuation error in a huge market segment than it takes to correct a valuation error in an individual stock.

davidw 7y ago
This lists 3575 stocks among its holdings, which includes both large and small cap stocks: https://investor.vanguard.com/mutual-funds/profile/overview/VTSAX/portfolio-holdings https://investor.vanguard.com/mutual-funds/profile/overview/...
- avvt4avaw 7y ago
  Sure, which is why I said that _most_ passive investments are not really passive. Vanguard Total Stock Market is pretty passive, as long as you consider your investment universe to be "US stocks". But even in this case the fund only holds stocks (no bonds or real estate) and only US stocks at that (no international or emerging market exposure).
groundlogic 7y ago
Mind explaining the concept of the marginal investor in this context?

deleted 7y ago

[deleted]

javagram 7y ago

https://www.marketwatch.com/story/john-bogle-has-a-warning-for-index-fund-investors-2017-06-01 https://www.marketwatch.com/story/john-bogle-has-a-warning-f... > Bogle pointed out that as indexing increases to a certain point, it opens opportunities for active investors to exploit inefficiencies in the pricing of some stocks. But past that point, wherever it might be — somewhere beyond 75%, in his view — the market could become a dangerous place.

nostromo 7y ago

> index funds can't work after a certain amount of the money poured into the system is managed by index funds That's not true. They'll still function just fine. What will likely change is that they will begin to underperform other strategies, including different types of indexing and active investing. At that point the market will self-correct and simple indexing will fall out of favor.

groundlogic 7y ago
Index funds have become successful since they've performed well compared to active investment funds. Why would the active investors suddenly get better at guessing the future?
- yifanl 7y ago
  Because when enough of the money is in an index fund, you can predict how a large part of the investors are going to invest (using the same algorithms they're using) and adjust based on that.
  - groundlogic 7y ago
    Kinda makes sense. Still, it sounds like a very fragile system. So instead if active fund managers "knowing the market better", we'll get active fund managers, "knowing the passive investor crowd better". This is madness.
    - yifanl 7y ago
      I mean, if the majority of the market is dumb passive index funds, those are one and the same :)
  - jandrese 7y ago
    That's it exactly. If the index funds get so big that they basically are the market, then active investors will have to adjust their view of the market to be effectively just whatever the index funds do. It may be possible that although they can't beat other active investors enough to justify their fees, they can beat a big dumb index fund enough to make their services worthwhile. That remains to be seen however.

TheCoelacanth 7y ago

It should be self-regulating, though. The higher the portion of the market that is passively investing, the easier it should be to beat their returns by actively investing so the more incentive there will be to actively invest.

toomuchtodo 7y ago
There’s an equilibrium to be reached, for sure. The market just hasn’t discovered what it is yet.
- abakker 7y ago
  I am not an economist either, but it seems that there is a danger in assuming there will be an equilibrium. I think it is entirely possible that there won't be one. If there is an equilibrium, it may take a significant price shock to discover where it is. I.e. that equilibrium could be years behind us, and if there is a crash we might never recover the value that our current market assumes is there.
whatok 7y ago
Once indexing gets to be a certain size, you run into the "markets irrational longer than you can stay solvent" issue at a much higher level. Active management "correction" doesn't really work if active managers are a much smaller portion of the market or no longer around at all.
- whatshisface 7y ago
  Holding doesn't change the price: buying moves it up and selling moves it down. An index fund holding 50% of all shares on the market but not trading them would have no influence at all on prices.
  - whatok 7y ago
    Did you mean to reply to my post? I don't see the relevance.

neilk 7y ago

I’m know I’m a dummy when it comes to economics, and an investor in index funds because of that. But it strikes me that index funds are parasitical in a way and depend on price signals from active investors. Some people say that it’s ok, the situation is self-correcting. But what if the smart active money is active in places we can’t see in the public markets? Again, I’m a dummy, but I believe a lot of investment is happening privately these days.

perardi 7y ago
You are not a dummy. Over the past 30 years, index funds have outperformed active management, especially when you consider the fees. You are a ”dummy” in the sense you don’t have perfect information awareness on every possibly tailwind or headwind that could impact a particular stock. But everyone is a dummy in that sense.
- davidw 7y ago
  > But everyone is a dummy in that sense. And even honest people well versed in economics will tell you that they are too.
fountainofage 7y ago
Private investment is absolutely where the money is these days. Look at how the media claims an IPO that doesn't pop 30% or more on day one is a "failure." No one who actually contributed to that company's value benefits from that pop, and best case scenario is really to either have the IPO be flat or even go down a little. But those elite that buy their way to the front of the line demand to have that 30% pop for contributing nothing. I'll just point out there's the argument about market makers and underwriting and blah blah blah. If that's such an issue just price that into the underwriter fees to begin with. No reason the public markets should lose out on a 30% gain to people that didn't actually take a risk and invest early in the company, and only intend to hold the stock for 8 hours at most.

whatshisface 7y ago

>but it's obvious to anyone used to thinking in terms of systems that index funds can't work after a certain amount of the money poured into the system is managed by index funds. If you have one trillion dollars invested, and the entire exchange volume is based on me and my friend trading a single share back and forth, everything will still work. It doesn't matter how much you own, because my friend and I are going to want a fair price for that one share in any case. There's no practical limit to how passive things can get before a problem kicks up, as long as a few hedge funds stay in.

kds3 7y ago
> entire exchange volume is based on me and my friend trading a single share back and forth, everything will still work You are talking like such a market is extremely liquid (there are enough shares for everyone). I think when a third person enters such a market your example breaks apart. Now you have one person who constantly wants to buy a stock but is unable to do so. Because you and your friend trade at a fair price and index fund does nothing. So he have to buy at an unfair price and rises his bid until index funds kicks in the game.

kccqzy 7y ago

> it's obvious to anyone used to thinking in terms of systems that index funds can't work after a certain amount of the money poured into the system is managed by index funds How so? I can certainly see "lost opportunities" where good stocks are undervalued just because they aren't in the index funds, but I don't understand why you think index funds can't work. Can you elaborate?

jldugger 7y ago

> What's the limit - 30% 40%, 50%, 60%? I'd wager at least 90 percent. Passive investing is generally designed to track active investor activity without effort, so it shouldn't add much inertia to the system. If Dave thinks IBM is overvalued and Under Armor is overvalued, the act of buying and selling will shift those numbers, and the index investors, instead of taking the opposite trade and undoing that flow of information, hold their portfolio. IMO, the real challenge is active investors competing for access to that 10 percent of active invested money. There's no shortage of people happy to manage money under the 'heads I win, tails you lose' fee structure, and one hopes that the same people fighting over a smaller pool of cash would (more strongly than status quo) favor people who can actually produce results.