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> Correction: index funds don't have a choice. They must follow the index, and so must buy the stock. Maybe, most indexes do not have to follow the index. they

by bluGill 5mo ago

> Correction: index funds don't have a choice. They must follow the index, and so must buy the stock. Maybe, most indexes do not have to follow the index. they just need to match the returns. An index fund manager has choice of what stocks to buy. However an index fund doesn't have enough managers to make many choices and so they normally buy just what is in the index. However all index fund managers know they are large enough that if they change their holdings "instantly" when the index it self changes the market will collapse and so the fund will under perform. Thus index fund managers are always trying to figure out what the index will do so they can start buying/selling stocks in smaller amounts before the change happens. How each fund handles this is up to the managers. (and "total market" funds have less ability and need to do this)

gitfan86 5mo ago
The whole point of index funds is that you don't have to pay management fees to managers. It's very expensive to hire a team of people to analyze the entire stock market in detail and chose the best 500 companies, and historically people who did that on average didn't beat the S&P500. Just look up the performance of Mutual Funds vs S&P500.
- bluGill 5mo ago
  That is the point, and index funds pay many less managers. However they all have a few managers to handle the various paperwork needed and those managers do make some decisions. They have much less influence vs a traditional funds, but it is slightly above zero.
  - daveshistory 5mo ago
    I think the point is that they don't have the influence to intentionally deviate from the index because they think they know better. If your mandate is to be passive, then you need an index to follow. If you are that sure the S&P 500 index is wrong for some reason, or whatever other index you follow, then you need to invent a new index. Then, you can follow the new index.
    - bluGill 5mo ago
      At least my index funds do that. They don't get to constantly trade like non-index funds do, and they typically stick with the index, but every index fund I own has a line about "we select stocks that we think will match the index", which is different from buying the stocks from the index. Again, the vast majority of the time they are matching the index stocks. However they have the right.
      - daveshistory 5mo ago
        I guess that's true but put yourself in the position of a major fund manager. Would you rather explain "We lost 3% this year because of a dumb IPO because we track an index that includes dumb IPOs," or would you rather say, "We lost 3% this year because I decided, as a passive fund manager, that the index was wrong and I knew better"? Your career would be over. Or at least, you would have to transition over to an active fund!
        nradov 5mo ago
        No, that's not how it works. The resource managers who hire and promote fund managers are well aware of how trading large blocks too quickly can skew pricing. No one expects performance to exactly match the index. Read the prospectus.
        khafra 5mo ago
        I'm willing to buy the idea that most fund managers have the lattitude to give SpaceX the standard seasoning period, instead of buying in right when they hit the index. Which funds will do that? If it's all or most of them, that'd be nice.
        daveshistory 5mo ago
        I don't know what to tell you guys because I am not a fund manager. If any of you are, then I'll go with what you're saying. But I do know how large organizations work first hand, and I'm sure lots of us do on here. Who exactly do you think wants to stick their neck out and say, "I work for a passive index fund. The whole premise of our career is that we don't try to play the market. But just this one time, I'm going to play the market anyway, and I'm going to use your money to do it." Sorry, not happening. If you don't like the fact that this stuff is going to be included in the index, then your only option is to stop buying the index. Of course they think they would think they're right. Everyone doing active investing always, every time, thinks they're right. They will buy the index the way they always do, and then they will say, "If you don't like it, take it up with the index." Watch the scene in Big Short at the bond rating agency for an indication of what's really going on here, is my guess.
- kmbfjr 5mo ago
  And their tax efficiency over mutual funds when outside tax advantaged accounts.
convolvatron 5mo ago
but any upside to second guessing the index gets allocated to the management, right? just like any downside, so its kind of immaterial for the end users, they're effectively bought into to SpaceX anyways
- bluGill 5mo ago
  They are judged by how close to the index their returns are. If there a significant deviation either way they are judged harshly. Each fund is different, but they typical thing they will do is buy a competitor of some company in the index once in a while. Typically managers pay is such that they don't get awards for guessing correctly, so they won't get any upside from a correct second guess, and they will see downsides from incorrect guesses. Also unlike traditional funds, there are not enough managers to follow every company, so they can't pick stocks that will win just because they don't have enough to time research the stock. When they pick a stock they are just looking at the high level will this company perform like the other peers in the industry long term.
  - wetgtgegsg 5mo ago
    [flagged]
    - jbs789 5mo ago
      They do track the index. The leeway to deviate is not intended to make bets on individual equities, but to - for example - match index returns with fewer execution costs. For example an index fund that tracks a global equity index may not find it practical to own shares in every listed company globally, but absolutely will be judged on its tracking error vs the benchmark index.
jayd16 5mo ago
So are they incentivized to allow an obvious grift and let the index have middling returns so they can skim the difference?
kybernetikos 5mo ago
> Maybe, most indexes do not have to follow the index. they just need to match the returns. This is a great technical point, and in a scenario where a constituent has a lot of obvious correlations it might be relevant, but when you've got something that is effectively a meme stock with erratic leadership and a huge range in possible outcomes from bankrupt to most valuable company ever in the universe [claude tells me I should say 'idiosyncratic returns' instead of this rant], I don't see how you promise to match the performance of an index where it's a significant component except by buying it.
- nradov 5mo ago
  They'll buy it, but they'll build a position gradually over months to approximately match the index. It won't be huge block buys on the IPO day.
Arn_Thor 5mo ago
The problem is, if you deviate too far from the index, your head is on the chopping block. There is no incentive to outperform the index, and every incentive to not meaningfully underperform it. Anyone bought into an index fund expects exact index performance (whether or not the prospectus technically allows for deviation). So any manager who values his pay check will say "the index may go up, may go down. The investor's paper wealth may increase or decrease. That's not my problem! And in a market like this, I risk underperforming if I don't own this asset. So of course I'm going to buy it!"

by bluGill 5mo ago

gitfan86 5mo ago

The whole point of index funds is that you don't have to pay management fees to managers. It's very expensive to hire a team of people to analyze the entire stock market in detail and chose the best 500 companies, and historically people who did that on average didn't beat the S&P500. Just look up the performance of Mutual Funds vs S&P500.

bluGill 5mo ago
That is the point, and index funds pay many less managers. However they all have a few managers to handle the various paperwork needed and those managers do make some decisions. They have much less influence vs a traditional funds, but it is slightly above zero.
- daveshistory 5mo ago
  I think the point is that they don't have the influence to intentionally deviate from the index because they think they know better. If your mandate is to be passive, then you need an index to follow. If you are that sure the S&P 500 index is wrong for some reason, or whatever other index you follow, then you need to invent a new index. Then, you can follow the new index.
  - bluGill 5mo ago
    At least my index funds do that. They don't get to constantly trade like non-index funds do, and they typically stick with the index, but every index fund I own has a line about "we select stocks that we think will match the index", which is different from buying the stocks from the index. Again, the vast majority of the time they are matching the index stocks. However they have the right.
    - daveshistory 5mo ago
      I guess that's true but put yourself in the position of a major fund manager. Would you rather explain "We lost 3% this year because of a dumb IPO because we track an index that includes dumb IPOs," or would you rather say, "We lost 3% this year because I decided, as a passive fund manager, that the index was wrong and I knew better"? Your career would be over. Or at least, you would have to transition over to an active fund!
      - nradov 5mo ago
        No, that's not how it works. The resource managers who hire and promote fund managers are well aware of how trading large blocks too quickly can skew pricing. No one expects performance to exactly match the index. Read the prospectus.
        khafra 5mo ago
        I'm willing to buy the idea that most fund managers have the lattitude to give SpaceX the standard seasoning period, instead of buying in right when they hit the index. Which funds will do that? If it's all or most of them, that'd be nice.
        daveshistory 5mo ago
        I don't know what to tell you guys because I am not a fund manager. If any of you are, then I'll go with what you're saying. But I do know how large organizations work first hand, and I'm sure lots of us do on here. Who exactly do you think wants to stick their neck out and say, "I work for a passive index fund. The whole premise of our career is that we don't try to play the market. But just this one time, I'm going to play the market anyway, and I'm going to use your money to do it." Sorry, not happening. If you don't like the fact that this stuff is going to be included in the index, then your only option is to stop buying the index. Of course they think they would think they're right. Everyone doing active investing always, every time, thinks they're right. They will buy the index the way they always do, and then they will say, "If you don't like it, take it up with the index." Watch the scene in Big Short at the bond rating agency for an indication of what's really going on here, is my guess.
kmbfjr 5mo ago
And their tax efficiency over mutual funds when outside tax advantaged accounts.

convolvatron 5mo ago

but any upside to second guessing the index gets allocated to the management, right? just like any downside, so its kind of immaterial for the end users, they're effectively bought into to SpaceX anyways

bluGill 5mo ago
They are judged by how close to the index their returns are. If there a significant deviation either way they are judged harshly. Each fund is different, but they typical thing they will do is buy a competitor of some company in the index once in a while. Typically managers pay is such that they don't get awards for guessing correctly, so they won't get any upside from a correct second guess, and they will see downsides from incorrect guesses. Also unlike traditional funds, there are not enough managers to follow every company, so they can't pick stocks that will win just because they don't have enough to time research the stock. When they pick a stock they are just looking at the high level will this company perform like the other peers in the industry long term.
- wetgtgegsg 5mo ago
  [flagged]
  - jbs789 5mo ago
    They do track the index. The leeway to deviate is not intended to make bets on individual equities, but to - for example - match index returns with fewer execution costs. For example an index fund that tracks a global equity index may not find it practical to own shares in every listed company globally, but absolutely will be judged on its tracking error vs the benchmark index.

jayd16 5mo ago

So are they incentivized to allow an obvious grift and let the index have middling returns so they can skim the difference?

kybernetikos 5mo ago

> Maybe, most indexes do not have to follow the index. they just need to match the returns. This is a great technical point, and in a scenario where a constituent has a lot of obvious correlations it might be relevant, but when you've got something that is effectively a meme stock with erratic leadership and a huge range in possible outcomes from bankrupt to most valuable company ever in the universe [claude tells me I should say 'idiosyncratic returns' instead of this rant], I don't see how you promise to match the performance of an index where it's a significant component except by buying it.

nradov 5mo ago
They'll buy it, but they'll build a position gradually over months to approximately match the index. It won't be huge block buys on the IPO day.

Arn_Thor 5mo ago

The problem is, if you deviate too far from the index, your head is on the chopping block. There is no incentive to outperform the index, and every incentive to not meaningfully underperform it. Anyone bought into an index fund expects exact index performance (whether or not the prospectus technically allows for deviation). So any manager who values his pay check will say "the index may go up, may go down. The investor's paper wealth may increase or decrease. That's not my problem! And in a market like this, I risk underperforming if I don't own this asset. So of course I'm going to buy it!"