8 ms·

Stock-market investors can no longer count on the ‘index effect’

77 points by lxm 4y ago

News-Dog 4y ago
Archive: https://archive.is/MDdHi https://archive.is/MDdHi To see all WSJ submissions to Hacker News:> https://news.ycombinator.com/from?site=wsj.com https://news.ycombinator.com/from?site=wsj.com
andrewmcwatters 4y ago
I suspect this is largely just because everyone has moved over to total stock market funds.
- lokar 4y ago
  Also it’s not that hard to predict well in advance and arbitrage away.
  - dnc 4y ago
    According to the article (and the discussed research) this was only a minor factor: "The researchers also explored the possibility that index changes are more predictable today than in the past, leading sophisticated market participants to trade ahead of the events. They concluded that this played only a minor role in their findings, however." The two main factors being: "...an increase in migrations over time from the S&P MidCap 400 index, and an overall increase in the market's ability to provide liquidity to those investors seeking to buy and sell around the time of index changes. The additional liquidity has 'made it easier for everyone to trade, and as a result, the prices move less.' says Dr. Greenwood. And with more stocks migrating to the S&P 500 from the S&P MidCap 400, midcap funds are selling as S&P 500 funds are buying, leading to 'a wash' in demand, he says. "
    - Kon-Peki 4y ago
      This factor is actually lessening over time. The BlackRocks and Vanguards of the world have dozens, even hundreds, of index funds - all with different benchmarks and goals. When a stock is "rebalanced" out of one fund, it ends up being added to some other fund that the same company manages. So the transfer occurs as a notation on the internal books; no actual arbitrage-able trade actually happens. This is even happening in the ESG space - we are starting to see fund "pairs" - one fund tracks the companies that meet the specific rules of that fund, and the other tracks the companies that do not. Note that this isn't perfect - index fund A has more assets under management than index fund B, etc. But as index investing grows, the actual investor inflows and outflows are what dominate, not rebalancing moves.
      - malshe 4y ago
        > This is even happening in the ESG space - we are starting to see fund "pairs" - one fund tracks the companies that meet the specific rules of that fund, and the other tracks the companies that do not. This is very interesting. Do you have any examples of these funds?
        Kon-Peki 4y ago
        There is an easy to understand white paper about this concept at CRSP’s website. Their particular ESG indexes aren’t investable, but it seems to be only a matter of time given that all their others are.
ipnon 4y ago
Doesn’t efficient market hypothesis make index investing guaranteed money long term in an expanding economy?
- FredPret 4y ago
  Guess the hypothesis doesn’t hold up then…
  - LoveMortuus 4y ago
    I would guess that you could still make some profit, since once the stock is added to S&P500 it will raise at least a bit, since many people do invest in the index, but I would guess that this change is less noticeable now that many more people are looking out for stocks that are going to be added or are close to be added to the index. I'm also guessing that many have algorithms that check for stocks that fulfill the criteria to be added to the index.
    - stouset 4y ago
      The whole point of this article is that, no, you can’t. This has already been priced in.
      - carabiner 4y ago
        Don't even ask the question. The answer is yes, it's priced in. Think Amazon will beat the next earnings? That's already been priced in. You work at the drive thru for Mickey D's and found out that the burgers are made of human meat? Priced in. You think insiders don't already know that? The market is an all powerful, all encompassing being that knows the very inner workings of your subconscious before you were even born. Your very existence was priced in decades ago when the market was valuing Standard Oil's expected future earnings based on population growth that would lead to your birth, what age you would get a car, how many times you would drive your car every week, how many times you take the bus/train, etc. Anything you can think of has already been priced in, even the things you aren't thinking of. You have no original thoughts. Your consciousness is just an illusion, a product of the omniscent market. Free will is a myth. The market sees all, knows all and will be there from the beginning of time until the end of the universe (the market has already priced in the heat death of the universe). So please, before you make a post on wsb asking whether AAPL has priced in earpods 11 sales or whatever, know that it has already been priced in and don't ask such a dumb fucking question again.
ggm 4y ago
They can't count on it, but they may still exploit it or attempt to. It's just less likely to be a significantly better strategy than others which tend to selling rapidly after acquisition, which is why this was profitable.
FredPret 4y ago
I built an algorithm to mass-analyze all the stocks on the US market. I don’t put too much faith in backtesting, but several basic Buffett-style value strategies seem to beat the S&P 500 handily, with less volatility.
- jiqiren 4y ago
  GitHub link?
- satvikpendem 4y ago
  Care to share the alpha with the rest of us? ;)
- Galanwe 4y ago
  That makes no sense. The last 10 to 20 years have seen a bullish round of momentum stocks negatively correlated to value loaded stocks. Value has consistently lost money in the last decade except for short times during momentum crashes in 2018 and 2023. Either your definition of value is inconsistent with the rest of the world, or your analysis is biased. Considering your sentence: > an algorithm to mass-analyze all the stocks on the US market I guess you reinvented some variation of"low vol" or "small vs big" signal. If you want to say you've beaten the S&P, you would have to show me a long short, beta neutral portfolio that does so using the same investment universe in a point in time manner.
  - jrockway 4y ago
    An algorithm could be anything, right? Maybe they analyzed the middle school report cards of executives and majority shareholders, and tied that to value over time in a way that the S&P 500 did. Maybe there's some telling data point that people have never looked at before. I agree that predicting future price based on the current price has likely been tried to death by billions of hedge funds, but who knows, maybe they found something new that nobody has ever noticed. And, you can come up with the best stock trading algorithm in history and still not have the capital necessary to execute it, so it's possible that portfolio results don't matter. I'm not saying anything is likely here, merely that we have nowhere near enough data to even speculate or offer advice.
satvikpendem 4y ago
What happens when everyone (or some sufficiently large portion of the population) index invests? I've heard it said that this becomes a problem, for whatever reason.
- gizmo686 4y ago
  In the limit, the market becomes completely detached from reality. In practice, the market will become increasingly irrational, leading to an increasing arbitrage opportunity for active investors. There may be a period where active investment gives a better ROI, even when accounting for fees; but in the long term, the amount of passive investment should reach an equilibrium where the benefits active investment is equal to its overhead.
  - satvikpendem 4y ago
    This is my thought as well, that the alpha would increase until it's enticing enough for active investors, but then I thought, most people are lazy and won't want to actively invest, so will this alpha ever decrease to an equilibrium state?
    - gizmo686 4y ago
      The more likely outcome is an increase in actively managed funds. Individuals will still contribute their money into the fund just like with index investing. However, instead of simply tracking an index, the fund would have a (team of) professional investors deciding how to invest on an ongoing basis, in exchange for a management fee. These exist today and are no more difficult to invest in than index funds. Of course, these also have higher overhead than index funds and, at the moment. Currently they are not popular because their performance relatively to an index does not justify their increased fees. If alpha gets high enough, this will stop being true and slowly the popular wisdom will update to saying that actively managed funds give a better ROI. There is also the Wall Street Bets class of active investors. In the current market, I'm not convinced they are actually helping. But, in a world where no one else is activly investing, they are probably better than nothing.
    - 4y ago
deleted 4y ago
[deleted]
thenerdhead 4y ago
Their conclusions: - an increase in migrations over time from the S&P MidCap Index - an overall increase in the market’s ability to provide liquidity to index changes What about the fact that there are more activities of additions/deletions to the S&P 500 given how much more competition there is today versus decades ago? You will see anywhere from 15-20 additions in recent years compared to 3-5 additions 30 years ago. Their figure 1 demonstrates this well: https://www.nber.org/system/files/working_papers/w30748/w30748.pdf https://www.nber.org/system/files/working_papers/w30748/w307... That to me just says the stock added to the S&P 500 has less time to actually accumulate said wealth to stay competitive on the top 500 list while the 1% of companies continue to reap the effect of it. Maybe that has something to do with the similar benefits of an index fund, the less activity, the more money you accumulate due to time in the market.
- RC_ITR 4y ago
  I think an addition to the liquidity point: Once something becomes "common knowledge" in the stock market, it looses all predictive power. In this example, you could trade on the index inclusion because it observably happened, but market participants didn't respond. Now, everyone expects the effect to happen, so it's just another thing 'baked in' to pricing.
- malshe 4y ago
  The returns are on a short period. From the paper: Our main interest is the total return, defined as the cumulative market-adjusted return from the last trading day before the announcement to the first trading day after the implementation. This has nothing to do with the "time in the market" as you mention above.
  - thenerdhead 4y ago
    Yeah so if people can profit short term off index rebalancing: https://archive.is/54uIY https://archive.is/54uIY Then stocks that have more "time on the S&P 500/index" are prone to survive and see higher returns also over the long term.

77 points by lxm 4y ago

Archive: https://archive.is/MDdHi https://archive.is/MDdHi To see all WSJ submissions to Hacker News:> https://news.ycombinator.com/from?site=wsj.com https://news.ycombinator.com/from?site=wsj.com

andrewmcwatters 4y ago

I suspect this is largely just because everyone has moved over to total stock market funds.

lokar 4y ago
Also it’s not that hard to predict well in advance and arbitrage away.
- dnc 4y ago
  According to the article (and the discussed research) this was only a minor factor: "The researchers also explored the possibility that index changes are more predictable today than in the past, leading sophisticated market participants to trade ahead of the events. They concluded that this played only a minor role in their findings, however." The two main factors being: "...an increase in migrations over time from the S&P MidCap 400 index, and an overall increase in the market's ability to provide liquidity to those investors seeking to buy and sell around the time of index changes. The additional liquidity has 'made it easier for everyone to trade, and as a result, the prices move less.' says Dr. Greenwood. And with more stocks migrating to the S&P 500 from the S&P MidCap 400, midcap funds are selling as S&P 500 funds are buying, leading to 'a wash' in demand, he says. "
  - Kon-Peki 4y ago
    This factor is actually lessening over time. The BlackRocks and Vanguards of the world have dozens, even hundreds, of index funds - all with different benchmarks and goals. When a stock is "rebalanced" out of one fund, it ends up being added to some other fund that the same company manages. So the transfer occurs as a notation on the internal books; no actual arbitrage-able trade actually happens. This is even happening in the ESG space - we are starting to see fund "pairs" - one fund tracks the companies that meet the specific rules of that fund, and the other tracks the companies that do not. Note that this isn't perfect - index fund A has more assets under management than index fund B, etc. But as index investing grows, the actual investor inflows and outflows are what dominate, not rebalancing moves.
    - malshe 4y ago
      > This is even happening in the ESG space - we are starting to see fund "pairs" - one fund tracks the companies that meet the specific rules of that fund, and the other tracks the companies that do not. This is very interesting. Do you have any examples of these funds?
      - Kon-Peki 4y ago
        There is an easy to understand white paper about this concept at CRSP’s website. Their particular ESG indexes aren’t investable, but it seems to be only a matter of time given that all their others are.

ipnon 4y ago

Doesn’t efficient market hypothesis make index investing guaranteed money long term in an expanding economy?

FredPret 4y ago
Guess the hypothesis doesn’t hold up then…
- LoveMortuus 4y ago
  I would guess that you could still make some profit, since once the stock is added to S&P500 it will raise at least a bit, since many people do invest in the index, but I would guess that this change is less noticeable now that many more people are looking out for stocks that are going to be added or are close to be added to the index. I'm also guessing that many have algorithms that check for stocks that fulfill the criteria to be added to the index.
  - stouset 4y ago
    The whole point of this article is that, no, you can’t. This has already been priced in.
    - carabiner 4y ago
      Don't even ask the question. The answer is yes, it's priced in. Think Amazon will beat the next earnings? That's already been priced in. You work at the drive thru for Mickey D's and found out that the burgers are made of human meat? Priced in. You think insiders don't already know that? The market is an all powerful, all encompassing being that knows the very inner workings of your subconscious before you were even born. Your very existence was priced in decades ago when the market was valuing Standard Oil's expected future earnings based on population growth that would lead to your birth, what age you would get a car, how many times you would drive your car every week, how many times you take the bus/train, etc. Anything you can think of has already been priced in, even the things you aren't thinking of. You have no original thoughts. Your consciousness is just an illusion, a product of the omniscent market. Free will is a myth. The market sees all, knows all and will be there from the beginning of time until the end of the universe (the market has already priced in the heat death of the universe). So please, before you make a post on wsb asking whether AAPL has priced in earpods 11 sales or whatever, know that it has already been priced in and don't ask such a dumb fucking question again.

ggm 4y ago

They can't count on it, but they may still exploit it or attempt to. It's just less likely to be a significantly better strategy than others which tend to selling rapidly after acquisition, which is why this was profitable.

FredPret 4y ago

I built an algorithm to mass-analyze all the stocks on the US market. I don’t put too much faith in backtesting, but several basic Buffett-style value strategies seem to beat the S&P 500 handily, with less volatility.

jiqiren 4y ago
GitHub link?
satvikpendem 4y ago
Care to share the alpha with the rest of us? ;)
Galanwe 4y ago
That makes no sense. The last 10 to 20 years have seen a bullish round of momentum stocks negatively correlated to value loaded stocks. Value has consistently lost money in the last decade except for short times during momentum crashes in 2018 and 2023. Either your definition of value is inconsistent with the rest of the world, or your analysis is biased. Considering your sentence: > an algorithm to mass-analyze all the stocks on the US market I guess you reinvented some variation of"low vol" or "small vs big" signal. If you want to say you've beaten the S&P, you would have to show me a long short, beta neutral portfolio that does so using the same investment universe in a point in time manner.
- jrockway 4y ago
  An algorithm could be anything, right? Maybe they analyzed the middle school report cards of executives and majority shareholders, and tied that to value over time in a way that the S&P 500 did. Maybe there's some telling data point that people have never looked at before. I agree that predicting future price based on the current price has likely been tried to death by billions of hedge funds, but who knows, maybe they found something new that nobody has ever noticed. And, you can come up with the best stock trading algorithm in history and still not have the capital necessary to execute it, so it's possible that portfolio results don't matter. I'm not saying anything is likely here, merely that we have nowhere near enough data to even speculate or offer advice.

satvikpendem 4y ago

What happens when everyone (or some sufficiently large portion of the population) index invests? I've heard it said that this becomes a problem, for whatever reason.

gizmo686 4y ago
In the limit, the market becomes completely detached from reality. In practice, the market will become increasingly irrational, leading to an increasing arbitrage opportunity for active investors. There may be a period where active investment gives a better ROI, even when accounting for fees; but in the long term, the amount of passive investment should reach an equilibrium where the benefits active investment is equal to its overhead.
- satvikpendem 4y ago
  This is my thought as well, that the alpha would increase until it's enticing enough for active investors, but then I thought, most people are lazy and won't want to actively invest, so will this alpha ever decrease to an equilibrium state?
  - gizmo686 4y ago
    The more likely outcome is an increase in actively managed funds. Individuals will still contribute their money into the fund just like with index investing. However, instead of simply tracking an index, the fund would have a (team of) professional investors deciding how to invest on an ongoing basis, in exchange for a management fee. These exist today and are no more difficult to invest in than index funds. Of course, these also have higher overhead than index funds and, at the moment. Currently they are not popular because their performance relatively to an index does not justify their increased fees. If alpha gets high enough, this will stop being true and slowly the popular wisdom will update to saying that actively managed funds give a better ROI. There is also the Wall Street Bets class of active investors. In the current market, I'm not convinced they are actually helping. But, in a world where no one else is activly investing, they are probably better than nothing.
  - 4y ago

deleted 4y ago

[deleted]

thenerdhead 4y ago

Their conclusions: - an increase in migrations over time from the S&P MidCap Index - an overall increase in the market’s ability to provide liquidity to index changes What about the fact that there are more activities of additions/deletions to the S&P 500 given how much more competition there is today versus decades ago? You will see anywhere from 15-20 additions in recent years compared to 3-5 additions 30 years ago. Their figure 1 demonstrates this well: https://www.nber.org/system/files/working_papers/w30748/w30748.pdf https://www.nber.org/system/files/working_papers/w30748/w307... That to me just says the stock added to the S&P 500 has less time to actually accumulate said wealth to stay competitive on the top 500 list while the 1% of companies continue to reap the effect of it. Maybe that has something to do with the similar benefits of an index fund, the less activity, the more money you accumulate due to time in the market.

RC_ITR 4y ago
I think an addition to the liquidity point: Once something becomes "common knowledge" in the stock market, it looses all predictive power. In this example, you could trade on the index inclusion because it observably happened, but market participants didn't respond. Now, everyone expects the effect to happen, so it's just another thing 'baked in' to pricing.
malshe 4y ago
The returns are on a short period. From the paper: Our main interest is the total return, defined as the cumulative market-adjusted return from the last trading day before the announcement to the first trading day after the implementation. This has nothing to do with the "time in the market" as you mention above.
- thenerdhead 4y ago
  Yeah so if people can profit short term off index rebalancing: https://archive.is/54uIY https://archive.is/54uIY Then stocks that have more "time on the S&P 500/index" are prone to survive and see higher returns also over the long term.