A Professor Who Was Right About Index Funds All Along • Hacker News Board

Re: A Professor Who Was Right About Index Funds All Along

#151

Post by ced » Sat, Oct 22, 2016, 6:43 PM UTC

jganetsk wrote: post #89

jbuzbee wrote: post #23

I'm a big believer in index funds and have been putting my money into them for a long time. But... you have to wonder where this is all ending up as more and more people move to passive index funds. The power of the market is based on millions of individual opinions on the price of a company's stock. On average, over time, these collective opinions will be correct. But say in the extreme case, it got to the point whe…

Warren Buffett says it's OK, and has an excellent explanation for this. If I recall correctly: imagine you take all the investors in the US economy and put them in a room. Divide the room in halves. One side contains all the active investors, the other side contains all the passive investors. If each side owns roughly half of the economy, their returns will be equal. In that case, it's better to sit on the side with…

imagine you take all the investors in the US economy and put them in a room. Divide the room in halves. One side contains all the active investors, the other side contains all the passive investors. If each side owns roughly half of the economy, their returns will be equal.

Won't the "tracking fee" of the index funds keep increasing, as a larger and larger fraction of the market is covered by them? Whenever a stock rises to X$, billions' worth of index funds will rush to buy the stock to rebalance their holdings, but clearly that should further raise the price of the stock (and they'll have to buy it at X+0.10, or X+0.50).

Re: A Professor Who Was Right About Index Funds All Along

#152

Post by billmalarky » Sat, Oct 22, 2016, 6:49 PM UTC

yborg wrote: post #119

nostromo wrote: post #112

Earlier quoted context omitted.

The irony of course is that Buffett became one of the world's richest people by being an active investor.

Precisely by being an investor in the old sense, the sense of being a businessman who allocates capital. He buys entire companies based on his analysis of their financials and management, and then operates them as businesses. He tries to take stakes in companies in deals where he holds an advantage, such as his Goldman Sachs investment. I don't consider him a stock picker, he's a very shrewd businessman.

In that sense his strategy is more aligned with private equity, but at the public scale...

Re: A Professor Who Was Right About Index Funds All Along

#153

Post by froogle » Sat, Oct 22, 2016, 6:51 PM UTC

ced wrote: post #151

jganetsk wrote: post #89

Earlier quoted context omitted.

Warren Buffett says it's OK, and has an excellent explanation for this. If I recall correctly: imagine you take all the investors in the US economy and put them in a room. Divide the room in halves. One side contains all the active investors, the other side contains all the passive investors. If each side owns roughly half of the economy, their returns will be equal. In that case, it's better to sit on the side with…

imagine you take all the investors in the US economy and put them in a room. Divide the room in halves. One side contains all the active investors, the other side contains all the passive investors. If each side owns roughly half of the economy, their returns will be equal. Won't the "tracking fee" of the index funds keep increasing, as a larger and larger fraction of the market is covered by them? Whenever a stock r…

Cap-weighted funds (like anything tracking the S&P 500) already hold the stocks in comparison to their market cap.

If a stock goes up, they don't need to buy more of it - the value of the shares they hold will increase to exactly the right proportion that they should have.

(There do exist other types of funds which try equally weight the stocks they hold, which means the fund has to rebalance when the stocks change price.)

Typically, cap-weighted funds only have to rebalance when individual members of the fund buy/sell - and they try to make it so people are buying/selling to those within the fund where possible to avoid having to do even that. The result is a very low churn, which is part of why index funds have lower fees.

Usually, the more assets an index fund has under management, the lower an index fund's fees get.

Re: A Professor Who Was Right About Index Funds All Along

#154

Post by dasil003 » Sat, Oct 22, 2016, 6:56 PM UTC

darawk wrote: post #142

jdmoreira wrote: post #9

Earlier quoted context omitted.

Luck can be the actual explanation. By the law of the large numbers, some funds will be a success for quite some time. Just as some people do win the lottery. I don't think it's surprising that a couple of funds have a great track history even if the game is just pure luck.

No, luck cannot be the explanation for what these quant funds do. These funds are run by mathematicians. People with PhD's in probability and physics. They are not being fooled by randomness. They are right, and they are right consistently. However, they are also at least generally, not making traditional 'investing' decisions. They are making statistical arbitrage bets - they are looking for instances where misprici…

Wow, this is the height of hubris. Of course luck can play a factor. There's no law of the universe that a correlation you observe over the past century of human activity is going to hold indefinitely. Obviously some quant funds have better models than others and it's not wrong to attribute that to intelligence and skill, but they absolutely can have the rug pulled out from under them by changing market conditions make no mistake.

Re: A Professor Who Was Right About Index Funds All Along

#155

Post by spitfire » Sat, Oct 22, 2016, 6:58 PM UTC

jacques_chester wrote: post #129

pooper wrote: post #125

Earlier quoted context omitted.

> True, but he (and Munger) generally invest quite conservatively. He doesn't buy for capital gain, but to hold indefinitely. He buys businesses he understands, with financials he understands, for prices he figures reflect a fair discount on the economic value, plus a generous margin of error. The Bank of America deal shows how good a deal you can get when you can put $5B where your mouth is > In exchange, Berkshire…

Right. In fact the financial crisis was a busy few years for Berkshire-Hathaway. Like everyone else they took a drubbing, but they also unleashed a lot of their unused cash to make deals on generous terms. It helped that they were structurally inclined to build up cash. As Buffet explains, a booming share market is bad for him: everything is too expensive to buy. So cash piles up, waiting for good deals of sufficient…

As Buffet puts it - Be greedy when others are fearful and fearful when others are greedy.

Re: A Professor Who Was Right About Index Funds All Along

#156

Post by ced » Sat, Oct 22, 2016, 7:01 PM UTC

froogle wrote: post #153

ced wrote: post #151

Earlier quoted context omitted.

imagine you take all the investors in the US economy and put them in a room. Divide the room in halves. One side contains all the active investors, the other side contains all the passive investors. If each side owns roughly half of the economy, their returns will be equal. Won't the "tracking fee" of the index funds keep increasing, as a larger and larger fraction of the market is covered by them? Whenever a stock r…

Cap-weighted funds (like anything tracking the S&P 500) already hold the stocks in comparison to their market cap. If a stock goes up, they don't need to buy more of it - the value of the shares they hold will increase to exactly the right proportion that they should have. (There do exist other types of funds which try equally weight the stocks they hold, which means the fund has to rebalance when the stocks change p…

That makes sense, thank you. Where does the tracking fee come from then?

EDIT: and doesn't my above argument hold at the boundary? When a stock is brought into the S&P, suddenly all of the index funds need to stock up on it, further bolstering its price, no?

Re: A Professor Who Was Right About Index Funds All Along

#157

Post by spectrum1234 » Sat, Oct 22, 2016, 7:07 PM UTC

jbuzbee wrote: post #23

I'm a big believer in index funds and have been putting my money into them for a long time. But... you have to wonder where this is all ending up as more and more people move to passive index funds. The power of the market is based on millions of individual opinions on the price of a company's stock. On average, over time, these collective opinions will be correct. But say in the extreme case, it got to the point whe…

Obviously day traders and fundamental investors still are doing their job to price each individual stock accurately.

This doesn't mean PASSIVE investors can't all do the same thing. In fact because risk over time is the fundamental reason passive investors make money, they can do exactly this. This isn't some loophole in the system. They are taking risk!!! It's amazing how many people don't understand this.

(edited)

Re: A Professor Who Was Right About Index Funds All Along

#158

Post by spectrum1234 » Sat, Oct 22, 2016, 7:12 PM UTC

kolbe wrote: post #111

I'm going to use this as an opportunity to yet again rail against the idea of indexing. It's a good thing in theory, but like most things, when it's taken to extremes, it's horrible. Passive investments wherein the investor takes zero interest in these investments are and have always been a terrible idea, and nothing in modern history has facilitated this more than index funds. When you give a friend of a friend $10,…

You are ignoring that with investing you are taking risk. If you ignore risk passive investments would already be priced higher. Risk == return when it comes to passive investing, of course over a very long time frame.

Re: A Professor Who Was Right About Index Funds All Along

#159

Post by harryh » Sat, Oct 22, 2016, 7:15 PM UTC

gist wrote: post #143

nostromo wrote: post #112

Earlier quoted context omitted.

The irony of course is that Buffett became one of the world's richest people by being an active investor.

Often overlooked is the fact that Buffett has used celebrity to his advantage. [1] Buffett gets to do deals (on better terms no less) that others can't as a result of his celebrity and this has been the case for a long long time. [1] In the same way Trump has but with a much better track record.

Yup.

http://www.mercenarytrader.com/2015/03/we-prefer-the-origina...

Re: A Professor Who Was Right About Index Funds All Along

#160

Post by froogle » Sat, Oct 22, 2016, 7:16 PM UTC

ced wrote: post #156

froogle wrote: post #153

Earlier quoted context omitted.

Cap-weighted funds (like anything tracking the S&P 500) already hold the stocks in comparison to their market cap. If a stock goes up, they don't need to buy more of it - the value of the shares they hold will increase to exactly the right proportion that they should have. (There do exist other types of funds which try equally weight the stocks they hold, which means the fund has to rebalance when the stocks change p…

That makes sense, thank you. Where does the tracking fee come from then? EDIT: and doesn't my above argument hold at the boundary? When a stock is brought into the S&P, suddenly all of the index funds need to stock up on it, further bolstering its price, no?

Fees come from the transaction costs of having to buy/sell shares (churn is low but non-zero), operate websites, paying salaries, running customer support, doing tax paperwork, etc. Not much magic there.

You're correct about what happens at the boundary, yes.

There's a well-known arbitrage opportunity for stocks that are known to be about to be brought into the S&P 500 (their prices DO tend to increase, I believe), if you want to research that. Like all publicly known arbitrages, I doubt you can make any money off it personally anymore though.

This is part of why the recommendation is not to use an S&P 500 fund, but something more like Vanguard's Total Stock Market fund, which includes medium/small-cap companies. Not that it's a huge deal, though - mutual fund companies are usually pretty clever about spreading large orders out over time.