Hacker News Board Hacker News, browsed like a classic message board
Live data from Hacker News

The Growing Peril of Index Funds: Too Much Tech

wsj.com

Post reply on HN
Print view View original

31–40 of 73 posts

Re: The Growing Peril of Index Funds: Too Much Tech

#31

Post by nostrademons »

tomp wrote: post #13
notadoc wrote: post #7

Well you could always avoid the tech heavy indices, but then you're sort of actively managing your positions rather than letting it be purely passive. Theoretically, is not another growing peril of indexing that it removes incentives for companies to behave well or outperform, since if they're part of an index their shares will be bought automatically by retirement plans and investors anyway, irregardless of performa…

> it surely must lose it's efficacy because it is no longer efficient, will indexing then not underperform Well, it's just a question of competitive advantages. In a world where so many people are trying to outperform the market, it's really hard to outperform the market and index funds essentially piggy-back to the aggregated wisdom of the best investors. In a world when the majority of investment and trading (the p…

Index funds don't have to do the majority of trading as long as they cannibalize the trading that would have occurred. Say that the majority of investable dollars is held in index funds that rebalance once/year, only trading then. The effect on liquidity & prices is that fewer trades are made and relevant information on the stock's future prospects takes longer to get reflected in the price. This opens up profitable investment opportunities for active fund managers to move in and buy up underpriced assets before the passive investments get in there, which then corrects the pricing imbalance (but not before the active fund managers have made a good profit).

Re: The Growing Peril of Index Funds: Too Much Tech

#32

Post by brndnmtthws »

ericjang wrote: post #26
brndnmtthws wrote: post #9

This is an inherent property of all market cap weighted indexes. An alternative approach is equal weighted indexes, which have historically outperformed market cap weighted indexes. There's no free lunch though: this is a case of your typical risk/reward tradeoff. Equal weighted funds are more risky (volatile), but have higher historic returns than market cap weighted funds. Some of them feature equal weighting acros…

Why are you so bullish in crypto? Would love to hear your thoughts here (or send me a DM if you prefer).

I usually direct people who ask about this toward Andreas Antonopoulos and Tom Lee (of Fundstrat). Bitcoin's value seems to mimic that of social networks, which suggests that Metcalfe's law applies. I don't trust governments, especially in the US where we have rampant crony capitalism, and I'm anti-borders, anti-military, and anti-authoritarianism.

There's plenty of good information on Reddit (/r/Bitcoin is pretty good, /r/btc is more like InfoWars), but of course you need to be able to wade through the BS. I'm a Bitcoin maximalist (and have about 80% of my holdings in Bitcoin), with some ETH and LTC, and a long list of alts that I think might have potential.

I also don't recommend investing in Bitcoin (or any other cryptocurrency) unless you have a high tolerance for risk and can afford to lose it.

Here's an aantonop playlist if you want to binge: https://www.youtube.com/playlist?list=PLPQwGV1aLnTthcG265_FY...

Re: The Growing Peril of Index Funds: Too Much Tech

#33

Post by zitterbewegung »

This looks like a PR piece to make people afraid of investing in the S&P. Some people have suggested thought that since investing in index funds makes the companies that are apart of the index fund to not compete with each other due to their shareholders. I'm not sure if the previous statement is even valid or real.

Re: The Growing Peril of Index Funds: Too Much Tech

#34

Post by rsync »

notadoc wrote: post #7

Well you could always avoid the tech heavy indices, but then you're sort of actively managing your positions rather than letting it be purely passive. Theoretically, is not another growing peril of indexing that it removes incentives for companies to behave well or outperform, since if they're part of an index their shares will be bought automatically by retirement plans and investors anyway, irregardless of performa…

"Theoretically, is not another growing peril of indexing that it removes incentives for companies to behave well or outperform, since if they're part of an index their shares will be bought automatically by retirement plans and investors anyway, irregardless of performance or competency?"

You don't have to look far to find this ... a great example is Restoration Hardware, which very recently borrowed money to buy back roughly half of the outstanding shares:

"The move has caused the company to consume basically all of its available cash balances and debt to increase by $500 million. In consequence, stockholder's equity has swung from $920 million at the end of the company's last fiscal year into slightly negative territory."[1]

This squeezed the shorts as well as (to the uninformed) bolstered their EPS dramatically as there are half as many shares now outstanding.

Nobody but an industry insider or other market-specific trading desk would have any interest in a disaster of a stock like this, and yet RH is in the Russell 3000 and is therefore auto-purchased by savers and retirees everywhere.

"if everyone is indexing, it surely must lose it's efficacy because it is no longer efficient, will indexing then not underperform?"

This was explained, I think, very succinctly in the Dave Collum "year in review"[2] wherein he explains:

"In his must-read book The Wisdom of Crowds, James Surowiecki posits that a large sample size of non-experts, when asked to wager a guess about something—the number of jelly beans in a jar, for example—will generate a distribution centered on the correct answer. Compared with experts, a crowd of clueless people offers more wisdom. I submit that this collective wisdom extends to democracies and markets alike. A critical requirement, however, is that the voting must be uncorrelated. Each player must vote or guess independently."

And that is precisely the issue we are worried about facing with index funds - we are buying indexes so as to access the (real, efficacious) wisdom of the crowd. However, if nobody actually makes a best guess - if there are no participants in the "guess voting" the wisdom of the crowd is lost.

[1] https://seekingalpha.com/article/4104757-shorts-restoration-...

[2] http://www.zerohedge.com/news/2017-12-23/dave-collums-2017-y...

Re: The Growing Peril of Index Funds: Too Much Tech

#36

Post by rsync »

module0000 wrote: post #27

The growing peril is only for long positions . Peril for long positions is profit for short positions. Seeing this article advising "reducing your exposure to tech by selling your tech stocks" assumes that you have no choice to participate other than buying . They are looking at half of the market(buy-side) and ignoring the equal-sized selling-side of the market. Stocks going down == Short the market. Stocks going up…

"The direction is unimportant, the volatility is absolutely important - and there is an awful lot of it(volatility) at the moment."

I am not sure what you mean by this - the asset market in general and the stock market in particular is historically non-volatile right now. Almost all asset classes are in lock-step correlation and fear indexes like the VIX are in such permanent languish that shorting the VIX has been one of the more profitable strategies for trading desks over the last few years.

Re: The Growing Peril of Index Funds: Too Much Tech

#37

Post by yborg »

rsync wrote: post #34
notadoc wrote: post #7

Well you could always avoid the tech heavy indices, but then you're sort of actively managing your positions rather than letting it be purely passive. Theoretically, is not another growing peril of indexing that it removes incentives for companies to behave well or outperform, since if they're part of an index their shares will be bought automatically by retirement plans and investors anyway, irregardless of performa…

"Theoretically, is not another growing peril of indexing that it removes incentives for companies to behave well or outperform, since if they're part of an index their shares will be bought automatically by retirement plans and investors anyway, irregardless of performance or competency?" You don't have to look far to find this ... a great example is Restoration Hardware, which very recently borrowed money to buy bac…

The crowd's wisdom extends to the indexer. Another issue with these index-linked funds is that they create a single point of failure, i.e. the few people at Russell that curate the index. It would be very very easy for someone to, um, externally compensate an individual or two at Russell to include a dog in the index for the purpose of a massive stock pop. Similar to the bond-rating agency fiasco(s) leading up to the 2008 crisis.

However, once an index is compromised like this, its overall returns will begin to suffer and people will move out of, say, Russell-linked funds. If it gets bad enough across the board, active-managed funds will begin to consistently outperform index funds and people will move their money there ... which presumably will rebalance the indexes. As far as I can see it, over the long term the system should self-correct.

Re: The Growing Peril of Index Funds: Too Much Tech

#38

Post by b4lancesh33t »

yborg wrote: post #37
rsync wrote: post #34

Earlier quoted context omitted.

"Theoretically, is not another growing peril of indexing that it removes incentives for companies to behave well or outperform, since if they're part of an index their shares will be bought automatically by retirement plans and investors anyway, irregardless of performance or competency?" You don't have to look far to find this ... a great example is Restoration Hardware, which very recently borrowed money to buy bac…

The crowd's wisdom extends to the indexer. Another issue with these index-linked funds is that they create a single point of failure, i.e. the few people at Russell that curate the index. It would be very very easy for someone to, um, externally compensate an individual or two at Russell to include a dog in the index for the purpose of a massive stock pop. Similar to the bond-rating agency fiasco(s) leading up to the…

It would also be pretty easy to spot something like that happening. If you see a stock in the Russell 3000 that is substantially less valuable than the distribution's tail would lead you to expect, then somebody is probably fucking with things. I would be astonished if Vanguard and other fund managers do not have automated monitoring to detect cases like this.

Re: The Growing Peril of Index Funds: Too Much Tech

#39

Post by uiri »

brndnmtthws wrote: post #9

This is an inherent property of all market cap weighted indexes. An alternative approach is equal weighted indexes, which have historically outperformed market cap weighted indexes. There's no free lunch though: this is a case of your typical risk/reward tradeoff. Equal weighted funds are more risky (volatile), but have higher historic returns than market cap weighted funds. Some of them feature equal weighting acros…

When it comes to an index like the S&P 500 where even some of the smaller components (e.g. Church & Dwight Co (read: Arm & Hammer), Hilton, etc) would be considered "large cap" then you probably want to do equal weighting rather than market cap weighting.

When it comes to something like Vanguard's Total Market, you probably want to put more money into the blue chip stocks than into the smaller companies at the bottom of the list (sorted by market cap). Smaller companies have lower trade volume/are less liquid which makes them subject to greater volatility/price fluctuations. There is no sense taking on greater risk there when the reward opportunity doesn't meaningfully increase with it.

Re: The Growing Peril of Index Funds: Too Much Tech

#40

Post by pedrocr »

brndnmtthws wrote: post #17
hendzen wrote: post #16

Earlier quoted context omitted.

What you want is an equal risk weighted SPY ETF - where each component is weighted such that the contribution to total volatility is equalized. This can be done using some off the shelf risk models from firms like MSCI. There was such an ETF (ERW), but it never really took off, and it no longer trades. Unfortunately these methods will just remain available to only more sophisticated market participants.

There's still a lot of opportunity for new types of passive index funds, using methods like you suggest. Maybe someone will start an up.

That's stretching the definition of passive investing. What the OP describes is an active strategy like any other. That you can automate it and wrap it in an ETF doesn't make it passive.
Post reply on HN