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This isn't taking into account that there is really no such thing as 'passive'. In reality, passive investors are constantly either investing with their paychec
by ItsMonkk 4y ago
This isn't taking into account that there is really no such thing as 'passive'. In reality, passive investors are constantly either investing with their paycheck, or selling in retirement. They are the world's simplest active investors. If you put money into passive then the index buys. If you request money, the index sells.
So what you need to track is the net flows. If the net flows are positive, and there is so little active left in the market that no matter what the active investors do the stock still has positive net flows, then active has no other option than to buy. This eventually leads to stocks having an infinite price as there is no downward force. On the other hand, if net flows are negative, then prices go to 0.
- im3w1l 4y agoThat's a passive failure mode I haven't seen before. To elaborate on what you said: Imagine an index, and an index fund tracking it. The index fund will own x% of every stock in the index. Someone buys the index fund, and the index fund now try to achieve x+epsilon% in every stock. But what if 100-x% of the stock is owned by diamond-hands hodlers, that wont sell at any price? The index fund bids higher and higher, and the sellers refuse to let their shares go, making the price reach ridiculous levels. The price reaching 0 seems less likely, as there will always be bargain hunters.
- dsr_ 4y agoYou're leaving out three factors: indexes are not static over long terms; the creation/destruction of new public corporations; and the possibility of existing public corporations offering more stock.
- nradov 4y agoIndex fund managers aren't idiots. Their trading systems still have a degree of sanity checking and human oversight, so they won't attempt to track the index exactly if things get weird. But for large-cap indexes like S&P 500, the "diamond-hands hodlers" lack the capital reserves necessary to really manipulate the market. At some point many of the underlying companies would also take advantage of excessive stock prices by issuing secondary offerings, thus increasing the supply.
- lupire 4y agoYah stock won't go to infinity. But TSLA joining the S&P 500 created synthetic demand that synthetically increased price/valuation.
- HALtheWise 4y agoThere's two key ways new stock can be created to avoid this risk: companies can issue it, or short sellers can create it. If the company sees its stock rising, it can and should see that as a cheap source of capital and absorb some of it through a stock sale to do more of whatever business they're in.
- ItsMonkk 4y agoYou think that companies are going to issue new stock in order to ensure that the value of their company doesn't go UP? If anything, the more they take out loans and buyback their stock, the faster it goes to infinity. And the faster it goes to infinity, the more collateral it has, to take out another loan, to buy more stock... And you think short-sellers are going to risk infinite losses? This is a prisoner's dilemma that you aren't going to win.
- jbay808 4y ago> If the company sees its stock rising, it can and should... absorb some of it through a stock sale That's ultimately down to the incentives in place. If the board members have a lot of options in their compensation package, they might prefer to see the stock price climb and climb. In fact if the incentives are set up that way they might do a buyback to help fuel the rise, even at the cost of longer-term harm to the company.
- nightski 4y agoShort sellers do not create stock. They are selling borrowed stocks. What am I missing.
- blibble 4y agothe genius thing about ETFs is they don't have to buy or sell the stock: others do it for them have a read about the creation/redemption mechanism and you'll see why this won't heppen
- thoughtstheseus 4y agoThey issue the person redeeming the the actual underlying securities. Then it’s up to them to sell it. Fun model.
- im3w1l 4y agoYeah, I knew about that. I had to look up their relative size to mutual funds though. Turns out mutual funds manage $23.9T compared to $5.4T in ETFs. I guess passive funds are more likely to be ETFs. But it could mean there is enough passive mutual fund money to pose a problem. https://www.investopedia.com/articles/exchangetradedfunds/08/etf-mutual-fund-difference.asp https://www.investopedia.com/articles/exchangetradedfunds/08...
- skybrian 4y agoThat’s an interesting way of looking at it, but it seems incomplete because for every buyer, there is a seller. A paycheck isn’t converted into stock, it’s traded for it, so some other account gets the cash. Supply and demand meant that asset prices went up, but that meant that the sellers got more cash for less stock. Who was selling? Recent retirees did well when they sold, but is there more to it than that? It’s an odd time when cash does poorly (inflation), bonds do worse, and the stock market fell. Prices are relative, though. I guess it’s all relative to commodities and labor. It seems like increased debt due to higher-priced assets as collateral probably needs to be taken into account too.
- throw0101a 4y ago> This isn't taking into account that there is really no such thing as 'passive'. In reality, passive investors are constantly either investing with their paycheck, or selling in retirement. They are the world's simplest active investors. If you put money into passive then the index buys. If you request money, the index sells. Passive investing means something, and what you are saying is not it. From William F. Sharpe, Nobel-winning economist who came up with capital asset pricing model (CAPM): > A passive investor always holds every security from the market, with each represented in the same manner as in the market. Thus if security X represents 3 per cent of the value of the securities in the market, a passive investor's portfolio will have 3 per cent of its value invested in X. Equivalently, a passive manager will hold the same percentage of the total outstanding amount of each security in the market[2]. * https://web.stanford.edu/~wfsharpe/art/active/active.htm https://web.stanford.edu/~wfsharpe/art/active/active.htm A "passive" investment strategy is not about not-buying/selling, but rather about not actively choosing particular financial instruments. > Passive management (also called passive investing) is an investing strategy that tracks a market-weighted index or portfolio.[1][2] Passive management is most common on the equity market, where index funds track a stock market index, but it is becoming more common in other investment types, including bonds, commodities and hedge funds.[3] * https://en.wikipedia.org/wiki/Passive_management https://en.wikipedia.org/wiki/Passive_management Following a particular index (NASDAQ, Dow Jones, S&P 500, Russell 3000, Wilshire 5000, TSX, FTSE 100, MSCI EAFE) is passive investing, even if you put in money every pay cheque.
- jleahy 4y agoTechnically speaking the Dow would not be a passive investment (by the definitions above), as it’s not market cap weighted.