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what happens in a theoretical market where 100% of investors were in an index funds? companies lucky enough to be listed in the S&P or whatever would get a hug

what happens in a theoretical market where 100% of investors were in an index funds? companies lucky enough to be listed in the S&P or whatever would get a huge influx of cash, but their actual quarterly performance wouldn't change whether people buy/sell their stock because people aren't picking and evaluating individual companies. so... what would determine their price?

neogodless 1y ago
Unless this theoretical market prevents individual investment, anyone who has opinions on any company being over- or under- valued would then be able to take advantage of the passive investors and make a lot of money buying and selling. And this would affect the price. But then it's no longer your theoretical market that is 100% passively invested.
- parpfish 1y ago
  but even if you know a company was under valued, you should only invest in it if you think it'll be 'properly valued' in the future. for that to work, there needs to be a mechanism for price discovery on individual stocks. but if (nearly) nobody is buying individual stocks, how would it be possible? and it's not even that the index fund is driving price discovery of the aggregate market because people using these funds just keep dumping money in on a schedule because they've internalized the message "time in market beats timing the market".
  - ljlolel 1y ago
    Discounted returns of dividend or buybacks from profits
dowager_dan99 1y ago
probably way more efficient as only a small group of the base index funds are doing company-by-company evaluation? If we contrast the sub-prime mortgage crisis where repackaging mixed in more and more dogshit every time, this feels like the opposite.
wing-_-nuts 1y ago
>what happens in a theoretical market where 100% of investors were in an index funds? That would never happen, because the more a market tilts towards index investing, the larger the incentive and opportunity that active management has to exploit misspriced assets. The trick is that the very act of exploiting that opportunity updates the price and eliminates it long term, and the harder it becomes for active investors to find misspriced assets. TLDR: Active managment effectively performs a service to the market, and gets rewarded for it, but the reward is small and fleeting
- entuno 1y ago
  I wonder if we reach a point where the concept of "mispriced" stops really making sense? Because when you say a stock is undervalued, isn't what you're really saying is that you think it's value with increase at a higher rate than the rest of the index in future, because it will attract above-average rates of investment from other active investors? Or to put it another way, "in the future more people will want to buy this stock than other stocks, so its value will go up". But if everyone else is the market is investing passively, where does disproportionate future demand come from?
  - wing-_-nuts 1y ago
    I think maybe you should go back to first principles. Why does a share of a company have any value? Well, if you buy 10% of the stock of widget co, you presumably get 10% of it's earnings, be that through dividends, share buy backs, etc. It's stock price will reflect that. It also reflects the future potential growth. For some companies, (utilities, etc) there isn't much future growth so the price is mostly a function of it's ability to pay out dividends. For a tech startup, they're not paying out dividends any time soon and the price reflects it's potential to someday be BigCo with massive earnings and massive dividends. There will always be active investors trying to beat the market, and they aid in price discovery.
    - entuno 1y ago
      So you think that active investors would shift much more towards trying to make money from dividends, rather than from speculation on the future share price?
psunavy03 1y ago
It's not being "lucky enough." It's based on market capitalization.

neogodless 1y ago

Unless this theoretical market prevents individual investment, anyone who has opinions on any company being over- or under- valued would then be able to take advantage of the passive investors and make a lot of money buying and selling. And this would affect the price. But then it's no longer your theoretical market that is 100% passively invested.

parpfish 1y ago
but even if you know a company was under valued, you should only invest in it if you think it'll be 'properly valued' in the future. for that to work, there needs to be a mechanism for price discovery on individual stocks. but if (nearly) nobody is buying individual stocks, how would it be possible? and it's not even that the index fund is driving price discovery of the aggregate market because people using these funds just keep dumping money in on a schedule because they've internalized the message "time in market beats timing the market".
- ljlolel 1y ago
  Discounted returns of dividend or buybacks from profits

dowager_dan99 1y ago

probably way more efficient as only a small group of the base index funds are doing company-by-company evaluation? If we contrast the sub-prime mortgage crisis where repackaging mixed in more and more dogshit every time, this feels like the opposite.

wing-_-nuts 1y ago

>what happens in a theoretical market where 100% of investors were in an index funds? That would never happen, because the more a market tilts towards index investing, the larger the incentive and opportunity that active management has to exploit misspriced assets. The trick is that the very act of exploiting that opportunity updates the price and eliminates it long term, and the harder it becomes for active investors to find misspriced assets. TLDR: Active managment effectively performs a service to the market, and gets rewarded for it, but the reward is small and fleeting

entuno 1y ago
I wonder if we reach a point where the concept of "mispriced" stops really making sense? Because when you say a stock is undervalued, isn't what you're really saying is that you think it's value with increase at a higher rate than the rest of the index in future, because it will attract above-average rates of investment from other active investors? Or to put it another way, "in the future more people will want to buy this stock than other stocks, so its value will go up". But if everyone else is the market is investing passively, where does disproportionate future demand come from?
- wing-_-nuts 1y ago
  I think maybe you should go back to first principles. Why does a share of a company have any value? Well, if you buy 10% of the stock of widget co, you presumably get 10% of it's earnings, be that through dividends, share buy backs, etc. It's stock price will reflect that. It also reflects the future potential growth. For some companies, (utilities, etc) there isn't much future growth so the price is mostly a function of it's ability to pay out dividends. For a tech startup, they're not paying out dividends any time soon and the price reflects it's potential to someday be BigCo with massive earnings and massive dividends. There will always be active investors trying to beat the market, and they aid in price discovery.
  - entuno 1y ago
    So you think that active investors would shift much more towards trying to make money from dividends, rather than from speculation on the future share price?

psunavy03 1y ago

It's not being "lucky enough." It's based on market capitalization.