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I think your use of theory and terms is right but you aren't visualizing how it would work in the world where nearly everyone is passive. Simplest example I ci

I think your use of theory and terms is right but you aren't visualizing how it would work in the world where nearly everyone is passive. Simplest example I cited already: it becomes obvious that company X will default in short order, but it's a member of an index and the market will "buy" it anyway: I can short it (by borrowing from the passives and selling it to them next time they buy the index) and never have to cover since it's bankrupt. That's a simple example of a single-player active skewering the passives. You can try to figure out what this means in terms of tracking error but it's kinda irrelevant to my point.

pedrocr 6y ago
In your hypothetical 99.9% passive scenario that doesn't work either because passive funds have long ago disallowed borrowing their stocks to short. If you start with a ~100% passive premise the reality is so different to what a normal market looks like you can't just propose a normal strategy and expect any of it to work.
- hncommenter13 6y ago
  Hi, I'm not sure I follow this idea that passive investors don't lend their shares. Is that meant to describe the hypothetical world of no active traders, as discussed above, or is it meant to describe the present situation in the investing world today? In the world as it stands today, passive ETFs and index mutual funds are a huge source of shares to lend. It's one of the ways they can lower the cost of the passive fund (or slightly increase returns above the passive benchmark), as the proceeds from lending shares are returned to investors in the fund. (Not always, but the good ETF operators do this.)
  - imtringued 6y ago
    If passive funds made this tradeoff then how would they be influenced by a company going bankrupt? They would just change the tradeoff when that becomes a problem since this is not part of the passive investment strategy.

pedrocr 6y ago

In your hypothetical 99.9% passive scenario that doesn't work either because passive funds have long ago disallowed borrowing their stocks to short. If you start with a ~100% passive premise the reality is so different to what a normal market looks like you can't just propose a normal strategy and expect any of it to work.

hncommenter13 6y ago
Hi, I'm not sure I follow this idea that passive investors don't lend their shares. Is that meant to describe the hypothetical world of no active traders, as discussed above, or is it meant to describe the present situation in the investing world today? In the world as it stands today, passive ETFs and index mutual funds are a huge source of shares to lend. It's one of the ways they can lower the cost of the passive fund (or slightly increase returns above the passive benchmark), as the proceeds from lending shares are returned to investors in the fund. (Not always, but the good ETF operators do this.)
- imtringued 6y ago
  If passive funds made this tradeoff then how would they be influenced by a company going bankrupt? They would just change the tradeoff when that becomes a problem since this is not part of the passive investment strategy.