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So I've been trying to work this out. Previously I understood the idea "The passives are simply the average of the actives". So even if you had 99% passive, so

So I've been trying to work this out. Previously I understood the idea "The passives are simply the average of the actives". So even if you had 99% passive, so long as the actives were doing their homework the system would work, but as you said you need to watch for exploits. But then I had the question: When the world has gone passive, who is left as an active investor? 1. Wallstreetbets users who do poorly on average, and they are small 2. Highly skilled Hedgefunds like Medallion who do great on average, but they are small 3. ... the company using debt to buyback its own shares So the key behind this entire stock market is that its a beauty contest where you need to make guesses as to what everyone else will do. But as active investors shrink with the increase in passive, what we are allowing happen is that the companies who use debt to buyback their shares are whats driving the market. Every dollar they spend on their stock is then magnified 100x by the big passive funds, and both 1 & 2 have no agency other than to try to get swept up in the winds. I have not yet done the intensive research to understand how large 3 can effect a stock, does anyone here have any idea if this will be a problem, and if we are already seeing signs that this is happening already?

saalweachter 6y ago
Think of it this way: if there are too many "free riders" in the form of passive investors, then ... it will become easier for active investors to make money, and beat the market, and more people will actively invest their money (or invest in actively managed funds).
- orojackson 6y ago
  Yep, there will usually be opportunities for arbitrage for active traders if there are too many passive investors. I suspect there will be some sort of equilibrium between active and passive at some point. The thing is that I'd rather be doing other things with my time, so I'm a passive investing kind of guy. Imagine getting the market return for doing nearly nothing for dirt cheap. That's a high growth rate to level of effort ratio!
- acover 6y ago
  An equilibrium exists but expected returns of active and passive are unknown. Would it reach equilibrium or could there be a crisis due to passive allocating funds poorly.
  - saalweachter 6y ago
    I mean, I don't know, I'm a random guy on the internet saying stuff, not an analyst. But I think a key point is that active investing already exists and dominates the market -- it's still like 85% active. People choosing to invest in passively managed funds are doing so because they see a higher return. Maybe the choice is sticky and people won't switch back if the returns begin to fall, but people still have to switch in. So building up a surplus of passive investors requires people to continue to switch to a passive strategy after the returns between passive and active level out and reverse. And not just a little -- profits from investing are returned to investors, and reinvested. So if the equilibrium between active and passive investing is X% of the market passive, and we get up to passive investors at X+10% of the market, then the X+10% of passive investors will see a lower rate of return than the 90-X% of active investors. Which means -- unless those active investors take their surplus profits and dump them into then-less-profitable passive funds, before long the active investors will have 91-X% of the market and the passive investors will have 9+X%. Absent continued switching, the feedback of profit re-investment will push the balance back to equilibrium.
- deleted 6y ago
  [deleted]
PascLeRasc 6y ago
You'd probably be interested in listening to this talk by Michael Green: https://www.youtube.com/watch?v=x-rJciYZmi0 https://www.youtube.com/watch?v=x-rJciYZmi0 He goes into a lot of data around the idea that the market is "too passive", and he believes that we were already at that point last year before the pandemic.
- ItsMonkk 6y ago
  I really enjoyed and learned a lot watching this, thanks.
xyzelement 6y ago
You got some good replies to your question (which is a very good one!) but I'll take a stab at it like this: A market is "too passive" when it becomes exploitable due to perfect predictability. But - that is the very thing that will keep it from ever reaching that level of passivity. Exploiting it is an active step, then someone else bets against the exploiter, etc.
worker767424 6y ago
> 2. Highly skilled Hedgefunds like Medallion who do great on average, but they are small Medallion usually does well, but hedge funds underperformed in the 2010's.
- david-gpu 6y ago
  > Medallion usually does well That's a bit of an understatement. The lowest yearly return since 1990 after fees and expenses has been 20%. Since 2005 their lowest yearly return has been 29%. They practically print their own money. Their strategies appear to have low capacity, I'll give you that.
Thorrez 6y ago
>the companies who use debt to buyback their shares are whats driving the market. Every dollar they spend on their stock is then magnified 100x by the big passive funds, and both 1 & 2 have no agency other than to try to get swept up in the winds. I've always found stock buybacks intriguing and confusing. Here's a hypothetical scenario that seems to go against what you're saying: Company A buys back $1 work of stock. Since there is now $1 less in Company A's bank account, that company is now worth $1 less. So the market cap should in theory be $1 less. Since the market cap should be $1 less, and $1 of stock disappeared, those perfectly balance out and mean the stock price should stay the same. Now the index investors take a look at the situation. Company A's market cap has shrunk, whereas other companies' market caps haven't. So Company A has a smaller share of the index than other companies than it had before. But the index investors still have the old ratio of Company A to other companies, so they are overinvested in Company A. They all sell a bit of Company A in order to get the correct balance according to the index. Company A goes down in value. So a stock buyback caused the price to go down.
- vomjom 6y ago
  market cap = book value + discounted future cash flows = share price * number of outstanding shares When you do a buyback, the book value drops (company loses cash), but the discounted future cash flows remains unchanged. The number of outstanding shares also drops. The net result is the stock price increases as a company accumulates cash and uses it for buybacks because the number of outstanding shares drops. Another way of thinking about it is that it's the same as dividends, but the dividend only goes to the sellers of the stock during a buyback.
  - mijamo 6y ago
    Market cap = whatever the market decided at that time, and is determined by offer and demand. The whole book value + discounted future cash flow does not reflect the real stock exchange at all. If that was the case no investor would want share buybacks because as you say it would only reward the ones who sell... When taking into account offer and demand stock buybacks make more sense: the buyback increase the demand for the stock. The offer will increase a bit (a few might sell) but not in the same proportion because the offer is not very elastic (most of your investors are in for a long ride and are not going to sell), so the price goes up, you get rid of some short term investors, and the long term investors see their share increasing in value. Everybody's happy and the dividend ratios do not mean anything anymore.
jamesmark 6y ago
Hello am mark barger from USA, i james mark . to say a very big thanks to Dr Macaulay for saving my soul from dying of Herpes Virus,i have being suffering from this Herpes Virus for two years now, i saw Dr Macaulay email address on a comment of someone who he has helped i was so encourage with the testimony been shared, i took the man email address and also contacted him for help he replied me and ask for some of my details which i provided and also ask for some useful Materials Needed for the herbal herbs which also did not cost me much, i provided all he needed from me to God be blessed this Dr prepared a parcel and send it to me followed with the instruction on how to take the herbal herbs medicine for 14 days. So surprisingly after taking the herbal herbs i went to the hospital for checkup to my greatness surprise my result came out (negative),i will never stop sharing my testimony of how i was cured from my Herpes Virus by Dr Macaulay you can also write him for any type of help you may need (Via:Dr.Macaulayherbalhome@yahoo.com) here his whatsapp https://wa.me/message/HJO6BWJEP4CFJ1mobile https://wa.me/message/HJO6BWJEP4CFJ1mobile number (+2349067522465) for help......
MR4D 6y ago
If you consider #3 and don’t limit it to only debt-driven buybacks, then the price increase can be absolutely insane. The best example is Berkshire Hathaway stock (BRK A share) which currently trades at $402,620 per share.

saalweachter 6y ago

Think of it this way: if there are too many "free riders" in the form of passive investors, then ... it will become easier for active investors to make money, and beat the market, and more people will actively invest their money (or invest in actively managed funds).

orojackson 6y ago
Yep, there will usually be opportunities for arbitrage for active traders if there are too many passive investors. I suspect there will be some sort of equilibrium between active and passive at some point. The thing is that I'd rather be doing other things with my time, so I'm a passive investing kind of guy. Imagine getting the market return for doing nearly nothing for dirt cheap. That's a high growth rate to level of effort ratio!
acover 6y ago
An equilibrium exists but expected returns of active and passive are unknown. Would it reach equilibrium or could there be a crisis due to passive allocating funds poorly.
- saalweachter 6y ago
  I mean, I don't know, I'm a random guy on the internet saying stuff, not an analyst. But I think a key point is that active investing already exists and dominates the market -- it's still like 85% active. People choosing to invest in passively managed funds are doing so because they see a higher return. Maybe the choice is sticky and people won't switch back if the returns begin to fall, but people still have to switch in. So building up a surplus of passive investors requires people to continue to switch to a passive strategy after the returns between passive and active level out and reverse. And not just a little -- profits from investing are returned to investors, and reinvested. So if the equilibrium between active and passive investing is X% of the market passive, and we get up to passive investors at X+10% of the market, then the X+10% of passive investors will see a lower rate of return than the 90-X% of active investors. Which means -- unless those active investors take their surplus profits and dump them into then-less-profitable passive funds, before long the active investors will have 91-X% of the market and the passive investors will have 9+X%. Absent continued switching, the feedback of profit re-investment will push the balance back to equilibrium.
deleted 6y ago
[deleted]

PascLeRasc 6y ago

You'd probably be interested in listening to this talk by Michael Green: https://www.youtube.com/watch?v=x-rJciYZmi0 https://www.youtube.com/watch?v=x-rJciYZmi0 He goes into a lot of data around the idea that the market is "too passive", and he believes that we were already at that point last year before the pandemic.

ItsMonkk 6y ago
I really enjoyed and learned a lot watching this, thanks.

xyzelement 6y ago

You got some good replies to your question (which is a very good one!) but I'll take a stab at it like this: A market is "too passive" when it becomes exploitable due to perfect predictability. But - that is the very thing that will keep it from ever reaching that level of passivity. Exploiting it is an active step, then someone else bets against the exploiter, etc.

worker767424 6y ago

> 2. Highly skilled Hedgefunds like Medallion who do great on average, but they are small Medallion usually does well, but hedge funds underperformed in the 2010's.

david-gpu 6y ago
> Medallion usually does well That's a bit of an understatement. The lowest yearly return since 1990 after fees and expenses has been 20%. Since 2005 their lowest yearly return has been 29%. They practically print their own money. Their strategies appear to have low capacity, I'll give you that.

Thorrez 6y ago

>the companies who use debt to buyback their shares are whats driving the market. Every dollar they spend on their stock is then magnified 100x by the big passive funds, and both 1 & 2 have no agency other than to try to get swept up in the winds. I've always found stock buybacks intriguing and confusing. Here's a hypothetical scenario that seems to go against what you're saying: Company A buys back $1 work of stock. Since there is now $1 less in Company A's bank account, that company is now worth $1 less. So the market cap should in theory be $1 less. Since the market cap should be $1 less, and $1 of stock disappeared, those perfectly balance out and mean the stock price should stay the same. Now the index investors take a look at the situation. Company A's market cap has shrunk, whereas other companies' market caps haven't. So Company A has a smaller share of the index than other companies than it had before. But the index investors still have the old ratio of Company A to other companies, so they are overinvested in Company A. They all sell a bit of Company A in order to get the correct balance according to the index. Company A goes down in value. So a stock buyback caused the price to go down.

vomjom 6y ago
market cap = book value + discounted future cash flows = share price * number of outstanding shares When you do a buyback, the book value drops (company loses cash), but the discounted future cash flows remains unchanged. The number of outstanding shares also drops. The net result is the stock price increases as a company accumulates cash and uses it for buybacks because the number of outstanding shares drops. Another way of thinking about it is that it's the same as dividends, but the dividend only goes to the sellers of the stock during a buyback.
- mijamo 6y ago
  Market cap = whatever the market decided at that time, and is determined by offer and demand. The whole book value + discounted future cash flow does not reflect the real stock exchange at all. If that was the case no investor would want share buybacks because as you say it would only reward the ones who sell... When taking into account offer and demand stock buybacks make more sense: the buyback increase the demand for the stock. The offer will increase a bit (a few might sell) but not in the same proportion because the offer is not very elastic (most of your investors are in for a long ride and are not going to sell), so the price goes up, you get rid of some short term investors, and the long term investors see their share increasing in value. Everybody's happy and the dividend ratios do not mean anything anymore.

jamesmark 6y ago

Hello am mark barger from USA, i james mark . to say a very big thanks to Dr Macaulay for saving my soul from dying of Herpes Virus,i have being suffering from this Herpes Virus for two years now, i saw Dr Macaulay email address on a comment of someone who he has helped i was so encourage with the testimony been shared, i took the man email address and also contacted him for help he replied me and ask for some of my details which i provided and also ask for some useful Materials Needed for the herbal herbs which also did not cost me much, i provided all he needed from me to God be blessed this Dr prepared a parcel and send it to me followed with the instruction on how to take the herbal herbs medicine for 14 days. So surprisingly after taking the herbal herbs i went to the hospital for checkup to my greatness surprise my result came out (negative),i will never stop sharing my testimony of how i was cured from my Herpes Virus by Dr Macaulay you can also write him for any type of help you may need (Via:Dr.Macaulayherbalhome@yahoo.com) here his whatsapp https://wa.me/message/HJO6BWJEP4CFJ1mobile https://wa.me/message/HJO6BWJEP4CFJ1mobile number (+2349067522465) for help......

MR4D 6y ago

If you consider #3 and don’t limit it to only debt-driven buybacks, then the price increase can be absolutely insane. The best example is Berkshire Hathaway stock (BRK A share) which currently trades at $402,620 per share.