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While I always preached just buying the S&P one risk i've been seeing with it is if, a majority of investors just buy the S&P index, since the index is market c

While I always preached just buying the S&P one risk i've been seeing with it is if, a majority of investors just buy the S&P index, since the index is market cap weighted, it would just make the largest stocks in the index more expensive. This would make the stocks that have less weight in the index or stocks outside the index relatively cheap and obviously offer better returns. Anyone disagree?

smabie 6y ago
Assuming the amount of tradable shares for each stock is proportional to the free float capitalization (which is not a particularly good assumption), each stock in the index should be pushed up by the same amount, since the weight of each stock in the index is proportional to the market cap of the stock. I don't think this is actually true (i.e the number of shares on the market is not proportional to the market cap), which would imply that some share prices would be affected more than other. Do higher weight stocks in spy get pushed up more? I don't know. But it is certainly possible. With respect to the stocks just outside the index, I think you could argue that they are probably undervalued and thus should offer better returns. This is what an academic would say. However, the actual reality could be a lot different: if returns are dominated by flows instead of fundamentals (like they are now), maybe going with the crowd is the best investment strategy. Or maybe not, I haven't done the research. One thing that every market professional is worried about right now is just how dysfunctional valuations and returns seem to be in the modern era. Stocks seem to go up for no reason and returns have been disconnected from both fundamental and quantitative risk premia. What I can say for sure is that we are in a period of intense change in the financial system. No one knows what the future of finance will look like, 10 years, 20, or 30 years out. Will crypto defi take over? Will traditional finance be disrupted? No one knows, but it is certainly an exciting time to work in the capital markets!
kgwgk 6y ago
Reality seems to disagree: https://www.sebastianstoeckl.com/post/ffdownload/index_files/figure-html/FF5-1.png https://www.sebastianstoeckl.com/post/ffdownload/index_files... https://en.wikipedia.org/wiki/Fama–French_three-factor_model#Fama–French_five-factor_model https://en.wikipedia.org/wiki/Fama–French_three-factor_model... SMB stands for "Small [market capitalization] Minus Big" and measures the historic excess returns of small caps over big caps.
- smabie 6y ago
  A lot of ff research is not very rigorous and highly suspect imo. it's more likely imo that smb is a risk premia than some sort of alpha factor
  - kgwgk 6y ago
    The factors in the Fama-French model are risk premia, I cannot make any sense of what you say. See for example https://www.msci.com/documents/1296102/1336482/Foundations_of_Factor_Investing.pdf https://www.msci.com/documents/1296102/1336482/Foundations_o...
    - smabie 6y ago
      Sorry, I'm using risk premia incorrectly (quant equities isn't actually my thing). What I mean is that I don't believe smb truly delivers superior risk adjusted returns. For example, I believe the betting against beta factor (BAB) does, while smb does not.
      - kgwgk 6y ago
        We agree then, the size factor has not been really outperforming since it was introduced in the nineties. Maybe the drivers of the outperformace were things like transaction costs and lack of information which are less of an issue in recent times. For what it’s worth, the value factor is not doing well recently either...
        smabie 6y ago
        you sound like a quant. are you l? if so, always like to network/talk/make connections hmu
        deleted 6y ago
        [deleted]
  - deleted 6y ago
    [deleted]

smabie 6y ago

Assuming the amount of tradable shares for each stock is proportional to the free float capitalization (which is not a particularly good assumption), each stock in the index should be pushed up by the same amount, since the weight of each stock in the index is proportional to the market cap of the stock. I don't think this is actually true (i.e the number of shares on the market is not proportional to the market cap), which would imply that some share prices would be affected more than other. Do higher weight stocks in spy get pushed up more? I don't know. But it is certainly possible. With respect to the stocks just outside the index, I think you could argue that they are probably undervalued and thus should offer better returns. This is what an academic would say. However, the actual reality could be a lot different: if returns are dominated by flows instead of fundamentals (like they are now), maybe going with the crowd is the best investment strategy. Or maybe not, I haven't done the research. One thing that every market professional is worried about right now is just how dysfunctional valuations and returns seem to be in the modern era. Stocks seem to go up for no reason and returns have been disconnected from both fundamental and quantitative risk premia. What I can say for sure is that we are in a period of intense change in the financial system. No one knows what the future of finance will look like, 10 years, 20, or 30 years out. Will crypto defi take over? Will traditional finance be disrupted? No one knows, but it is certainly an exciting time to work in the capital markets!

kgwgk 6y ago

Reality seems to disagree: https://www.sebastianstoeckl.com/post/ffdownload/index_files/figure-html/FF5-1.png https://www.sebastianstoeckl.com/post/ffdownload/index_files... https://en.wikipedia.org/wiki/Fama–French_three-factor_model#Fama–French_five-factor_model https://en.wikipedia.org/wiki/Fama–French_three-factor_model... SMB stands for "Small [market capitalization] Minus Big" and measures the historic excess returns of small caps over big caps.

smabie 6y ago
A lot of ff research is not very rigorous and highly suspect imo. it's more likely imo that smb is a risk premia than some sort of alpha factor
- kgwgk 6y ago
  The factors in the Fama-French model are risk premia, I cannot make any sense of what you say. See for example https://www.msci.com/documents/1296102/1336482/Foundations_of_Factor_Investing.pdf https://www.msci.com/documents/1296102/1336482/Foundations_o...
  - smabie 6y ago
    Sorry, I'm using risk premia incorrectly (quant equities isn't actually my thing). What I mean is that I don't believe smb truly delivers superior risk adjusted returns. For example, I believe the betting against beta factor (BAB) does, while smb does not.
    - kgwgk 6y ago
      We agree then, the size factor has not been really outperforming since it was introduced in the nineties. Maybe the drivers of the outperformace were things like transaction costs and lack of information which are less of an issue in recent times. For what it’s worth, the value factor is not doing well recently either...
      - smabie 6y ago
        you sound like a quant. are you l? if so, always like to network/talk/make connections hmu
      - deleted 6y ago
        [deleted]
- deleted 6y ago
  [deleted]