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"statistically proven reality" is an oxymoron - past outperformance of passive funds (statistics) are no guarantee of future returns (reality). Some of the mat

"statistically proven reality" is an oxymoron - past outperformance of passive funds (statistics) are no guarantee of future returns (reality). Some of the math surrounding the derivation of the weakest forms of EMT also relies on the assumption that everyone has access to the same information, which is patently false in the world we live in. Even retail traders sometimes have an information edge (e.g. working at a biotech company or a specialized industry like semiconductors)

yoz-y 5y ago
Please correct me if I’m wrong. But I assume that earning while holding is based on an assumption that the overall productivity continues to rise, while active trading is more of a zero sum game. Any gains you earn is somebody’s loss. Now, the initial assumption could very well hit a wall.
- baq 5y ago
  notice you're contradicting yourself: active traders don't only trade with other active traders, they also trade with those same passive funds that bet on continuous growth in fundamentals of companies and the hope that eventually that growth will be reflected in the stock price. then consider just how much shares passive funds move all the time due to continuous rebalancing they do due to their self-imposed mandate. (reminder: etfs hold ~$5T worth of assets.)
  - freetime2 5y ago
    > Then consider just how much shares passive funds move all the time due to continuous rebalancing they do due to their self-imposed mandate. One of the big selling points of passive, market weighted ETFs is their low turnover and high tax efficiency. Vanguard’s S&P 500 ETF (VOO) has an annual turnover of 4%, for example. That’s nothing compared to the turnover in an actively traded portfolio. Sure they do a lot of trading volume to account for inflows and outflows from the ETF. But one of the very nice properties of market weighting is that there is hardly any rebalancing needed as individual assets drift in price.
    - thekyle 5y ago
      Yes indeed, last I heard passive funds made up 50% of AUM but only 5% of trading. In other words, 95% of price discovery is still done by active managers.
- glofish 5y ago
  It makes no sense to say that active trading is zero sum but passive trading isn't. Either both are or none are. Holding an asset for N days does not magically flip it from category to the other.
  - AnimalMuppet 5y ago
    Yes, but a bit of no. Yes, if the market is overall rising, then active trading should enjoy that overall rise just like buy and hold does. But then why active trade? Because you think you can do better than passive. That part - the "doing better" part - is zero sum. In fact it's negative sum, because of transaction costs.
    - cortesoft 5y ago
      This assumes that all money stays in the market. Some people selling shares to active traders are pulling money out of the market to use for other purposes. Are they ‘losing’ money because they don’t get the profits from a later rise in price? Maybe, but it isnt so cut and dry.
bkberry352 5y ago
I don’t think anyone would argue with the statement “if you possess an information advantage then you’re better off actively trading”. It’s mostly in the situation where you don’t have an information advantage that passive investing outperforms (on average). The fun part is that everyone _thinks_ they have an information advantage, but fewer really do.
- jjeaff 5y ago
  To complicate the benefit of an information advantage is that regardless of publicly available information, stock price is still set by psychology and that can be irrational. And that leads to the oft repeated "the markets can remain irrational longer than you can remain solvent."
pedrocr 5y ago
The derivation that in total the passives outperform the actives is not a statistical result from historical data and doesn't require efficient market assumptions at all. It's just basic arithmetic that holds over any time period that the passives as a group will have the same returns as the actives as a group but spend less on fees. Sharpe's webpage on that gives a simple rundown of the calculations: https://web.stanford.edu/~wfsharpe/art/active/active.htm https://web.stanford.edu/~wfsharpe/art/active/active.htm That doesn't mean there haven't been long-running active strategies that have worked. But those have overperformed by grabbing returns from other actives underperforming, not the passives.
- im3w1l 5y ago
  The mistake you make is to think of two groups, when there are actually three. Active, passive and "outiders", who got their stock outside of the stock market. Maybe they are early investors or maybe they get stock as part of their compensation package. If passive investors make worse trades with outsiders than the active investors do, they will underperfom.
- ericjang 5y ago
  > From this, it follows (as the night from the day) that the return on the average actively managed dollar must equal the market return. Why? Because the market return must equal a weighted average of the returns on the passive and active segments of the market. If the first two returns are the same, the third must be also. Let me try to poke some holes in the argument. 1. Market return (M) is a weighted combination of passive (P) and actively managed portfolio (A) returns: M = (1-w)P+(w)A. 2. Passive investor achieves market return M by holding the whole market, so P = M. 3. To satisfy the equation, A must also be M, regardless of w. The logical error is in the assumption that P = M. To make this a concrete programming problem: let's say at time t=1, immediately prior to the start of a trading period, a passive investor decides to construct a portfolio. The passive investor makes investment allocations based on the current set of market prices. Subsequently, how can the passive investor possibly match market returns without w being 0, or the passive investor knowing exactly how the active investors will allocate their holdings? That information lies in the future - one only needs to go though the exercise of simulating market returns on a discrete time basis to realize that the passive investor cannot possibly allocate to achieve exactly market returns. M[1] = (1-w[1])P[1]+w[1]A[1]

yoz-y 5y ago

Please correct me if I’m wrong. But I assume that earning while holding is based on an assumption that the overall productivity continues to rise, while active trading is more of a zero sum game. Any gains you earn is somebody’s loss. Now, the initial assumption could very well hit a wall.

baq 5y ago
notice you're contradicting yourself: active traders don't only trade with other active traders, they also trade with those same passive funds that bet on continuous growth in fundamentals of companies and the hope that eventually that growth will be reflected in the stock price. then consider just how much shares passive funds move all the time due to continuous rebalancing they do due to their self-imposed mandate. (reminder: etfs hold ~$5T worth of assets.)
- freetime2 5y ago
  > Then consider just how much shares passive funds move all the time due to continuous rebalancing they do due to their self-imposed mandate. One of the big selling points of passive, market weighted ETFs is their low turnover and high tax efficiency. Vanguard’s S&P 500 ETF (VOO) has an annual turnover of 4%, for example. That’s nothing compared to the turnover in an actively traded portfolio. Sure they do a lot of trading volume to account for inflows and outflows from the ETF. But one of the very nice properties of market weighting is that there is hardly any rebalancing needed as individual assets drift in price.
  - thekyle 5y ago
    Yes indeed, last I heard passive funds made up 50% of AUM but only 5% of trading. In other words, 95% of price discovery is still done by active managers.
glofish 5y ago
It makes no sense to say that active trading is zero sum but passive trading isn't. Either both are or none are. Holding an asset for N days does not magically flip it from category to the other.
- AnimalMuppet 5y ago
  Yes, but a bit of no. Yes, if the market is overall rising, then active trading should enjoy that overall rise just like buy and hold does. But then why active trade? Because you think you can do better than passive. That part - the "doing better" part - is zero sum. In fact it's negative sum, because of transaction costs.
  - cortesoft 5y ago
    This assumes that all money stays in the market. Some people selling shares to active traders are pulling money out of the market to use for other purposes. Are they ‘losing’ money because they don’t get the profits from a later rise in price? Maybe, but it isnt so cut and dry.

bkberry352 5y ago

I don’t think anyone would argue with the statement “if you possess an information advantage then you’re better off actively trading”. It’s mostly in the situation where you don’t have an information advantage that passive investing outperforms (on average). The fun part is that everyone _thinks_ they have an information advantage, but fewer really do.

jjeaff 5y ago
To complicate the benefit of an information advantage is that regardless of publicly available information, stock price is still set by psychology and that can be irrational. And that leads to the oft repeated "the markets can remain irrational longer than you can remain solvent."

pedrocr 5y ago

The derivation that in total the passives outperform the actives is not a statistical result from historical data and doesn't require efficient market assumptions at all. It's just basic arithmetic that holds over any time period that the passives as a group will have the same returns as the actives as a group but spend less on fees. Sharpe's webpage on that gives a simple rundown of the calculations: https://web.stanford.edu/~wfsharpe/art/active/active.htm https://web.stanford.edu/~wfsharpe/art/active/active.htm That doesn't mean there haven't been long-running active strategies that have worked. But those have overperformed by grabbing returns from other actives underperforming, not the passives.

im3w1l 5y ago
The mistake you make is to think of two groups, when there are actually three. Active, passive and "outiders", who got their stock outside of the stock market. Maybe they are early investors or maybe they get stock as part of their compensation package. If passive investors make worse trades with outsiders than the active investors do, they will underperfom.
ericjang 5y ago
> From this, it follows (as the night from the day) that the return on the average actively managed dollar must equal the market return. Why? Because the market return must equal a weighted average of the returns on the passive and active segments of the market. If the first two returns are the same, the third must be also. Let me try to poke some holes in the argument. 1. Market return (M) is a weighted combination of passive (P) and actively managed portfolio (A) returns: M = (1-w)P+(w)A. 2. Passive investor achieves market return M by holding the whole market, so P = M. 3. To satisfy the equation, A must also be M, regardless of w. The logical error is in the assumption that P = M. To make this a concrete programming problem: let's say at time t=1, immediately prior to the start of a trading period, a passive investor decides to construct a portfolio. The passive investor makes investment allocations based on the current set of market prices. Subsequently, how can the passive investor possibly match market returns without w being 0, or the passive investor knowing exactly how the active investors will allocate their holdings? That information lies in the future - one only needs to go though the exercise of simulating market returns on a discrete time basis to realize that the passive investor cannot possibly allocate to achieve exactly market returns. M[1] = (1-w[1])P[1]+w[1]A[1]