A critique of the claim that passive investing is a bubble • Hacker News Board

Re: A critique of the claim that passive investing is a bubble

#181

Post by vkou » Thu, Sep 05, 2019, 9:51 PM UTC

lovecg wrote: post #176

vkou wrote: post #146

Earlier quoted context omitted.

An evil mirror universe twin of you, instead of owning an ETF, owns a bunch of shares of APPL, a bunch of shares of GOOGL, a bunch of shares of stock X. If you are panicked, and are selling your ETF, your evil twin is panicked, and selling all their stocks. This causes the exact same downwards pressure on the market. I don't buy an ETF because I want someone to do financial malarkey with my money. I buy it because I…

The argument is that the automation at scale that ETFs bring to the table changes the game qualitatively. How many people would really buy and sell thousands of individual stocks in a correlated fashion if this infrastructure didn’t exist?

No, they'd have a dozen individual stocks that they would own, and when you combine fifty million people, each owning a dozen individual stocks, you'd get a pretty accurate proxy for the S&P 500.

They'd still follow the same herd mentality that they would, had they owned ETFs.

Re: A critique of the claim that passive investing is a bubble

#182

Post by throw0101a » Thu, Sep 05, 2019, 10:08 PM UTC

rocqua wrote: post #142

human20190310 wrote: post #10

Earlier quoted context omitted.

> ...will drive the market down So what? Let the weak long positions panic and sell at the bottom. Everyone else gets a few years of discount prices to buy. The hardest hit will be those who are leveraged and arguably deserve to get hosed for taking that much risk. If you don’t have to meet a margin call, you can ride out a crisis; if you’ve got cash in reserve, you can profit from it.

Presuming you are saving for later. Besides a margin call, you might want to exit for, buying a house, going into retirement, covering a period between jobs, or to deal with a medical emergency. Doing that during a crisis hurts. This risk diminishes the value of investments as a safety cushion.

> Besides a margin call, you might want to exit for, buying a house, going into retirement, covering a period between jobs, or to deal with a medical emergency.

In all of those scenarios you should not be in stocks/equities in the first place. If there is a possibility of needing cash with-in the next 5 years, that money should be in either bonds or term deposits.

One's downpayment, first/next few retirement years' income, and emergency fund(s) should not be in equities.

Re: A critique of the claim that passive investing is a bubble

#183

Post by throw0101a » Thu, Sep 05, 2019, 10:19 PM UTC

awillen wrote: post #7

As I read it, the word bubble in the Burry interview was really just used for clickbait purposes - his argument wasn't so much that index funds are overvalued, it was that there's opportunity in small caps because they're underrepresented in index funds, and everyone else is investing in index funds.

> his argument wasn't so much that index funds are overvalued, it was that there's opportunity in small caps because they're underrepresented in index funds, and everyone else is investing in index funds.

Which index fund though? If you're talking about VOO, which follows the S&P500, maybe. If you're talking about VTI (CRSP US Total Market Index), probably less so.

See also Russell 3000 and Wilshire 5000.

Re: A critique of the claim that passive investing is a bubble

#184

Post by awillen » Thu, Sep 05, 2019, 10:27 PM UTC

throw0101a wrote: post #183

awillen wrote: post #7

As I read it, the word bubble in the Burry interview was really just used for clickbait purposes - his argument wasn't so much that index funds are overvalued, it was that there's opportunity in small caps because they're underrepresented in index funds, and everyone else is investing in index funds.

> his argument wasn't so much that index funds are overvalued, it was that there's opportunity in small caps because they're underrepresented in index funds, and everyone else is investing in index funds. Which index fund though? If you're talking about VOO, which follows the S&P500, maybe. If you're talking about VTI (CRSP US Total Market Index), probably less so. See also Russell 3000 and Wilshire 5000.

Well inasmuch as he's talking generally about index funds and where money is going, he's going to be talking about the major ones, like those that track the S&P.

Re: A critique of the claim that passive investing is a bubble

#185

Post by hyperpape » Thu, Sep 05, 2019, 10:34 PM UTC

dcolkitt wrote: post #180

hyperpape wrote: post #169

Earlier quoted context omitted.

This is a great explanation. Can you explain why this isn't a problem for actively managed funds, though? Do they just avoid stocks like CB?

No, I think in such a scenario active investors would wind up getting just as whalloped as passive investors. By definition active investors in aggregate have the same average exposure as cap-weighted indexers to any given stock. Arguably, after the crash they might be able to take advantage of the opportunity. If they concentrate into the stocks with the biggest price displacements, then as those stocks return to no…

I'm not sure I stated my question clearly enough. I'm not asking whether active funds would fare better than index funds in a downturn, though it's interesting to hear.

I'm asking for a comparison of two scenariors. In the index fund scenario, we're in the world where index funds represent a large and growing chunk of the market. In the active funds scenario, index funds aren't a thing. Why is it that in the active funds scenario, what you're describing in the previous post doesn't happen? Why doesn't a 20% marketwide downturn cause chaos in these smaller stocks? Is it because there would be higher volumes if those stocks were held by active funds? Or because the active funds wouldn't hold stocks like that?

Basically, I'm asking for a comparison of the scenario you described with what happens in a no-index world, because I can't quite think through the difference myself.

Re: A critique of the claim that passive investing is a bubble

#186

Post by id » Thu, Sep 05, 2019, 10:41 PM UTC

AlanSE wrote: post #124

newshorts wrote: post #75

> When an index fund investor sells, they’re technically selling their holdings in direct proportion to their weighting in the index. So there is literally no market impact. Correct me if I’m wrong but isn’t there a well known price premium for stocks included in major index funds? As I understand it, the most popular indexes target a few companies, thus index funds that track them funnel a disproportionate volume of…

I've asked this question before and consistently failed to get a clear answer - why is there any deviation between index fund weighting and market cap? To some extent, I'm sure the definition of a "public" company comes into play. Not all stocks are traded in all exchanges, so you could include stocks only listed on one exchange. Then there's the practice of many index funds picking the top N stocks by market cap. Th…

>The small cap stocks should be limited in weight by... their small market cap.

A lot of index funds include small caps nowadays. Not all of them because it's more difficult to track 4000 versus 500 stocks. Also the more popular indexes have usually been around for a long time and have fewer constituents.

>it seems that weight does not correspond to capitalization

Pretty much all index funds invest in the public float and it makes sense:

https://en.wikipedia.org/wiki/Public_float

Re: A critique of the claim that passive investing is a bubble

#187

Post by jonknee » Thu, Sep 05, 2019, 11:03 PM UTC

AlanSE wrote: post #124

newshorts wrote: post #75

> When an index fund investor sells, they’re technically selling their holdings in direct proportion to their weighting in the index. So there is literally no market impact. Correct me if I’m wrong but isn’t there a well known price premium for stocks included in major index funds? As I understand it, the most popular indexes target a few companies, thus index funds that track them funnel a disproportionate volume of…

I've asked this question before and consistently failed to get a clear answer - why is there any deviation between index fund weighting and market cap? To some extent, I'm sure the definition of a "public" company comes into play. Not all stocks are traded in all exchanges, so you could include stocks only listed on one exchange. Then there's the practice of many index funds picking the top N stocks by market cap. Th…

Why shouldn't there be lots of kinds of indexes? There are certainly ones like you describe. In practice it just doesn't matter, the large companies are so much larger that adding even thousands of tiny companies doesn't move the needle.

VTI is Vanguard's total stock market ETF which works like what you suggest. It has 3,606 stocks, year-to-date it's up 18.82%. Compare that to Vanguard's S&P 500 ETF VOO which is up 19.03%.

When a company hits its stride and is large enough to really make it difference it will join the S&P 500. I guess if there were a lot more than 500 companies that you should own there would be a problem, but we're not there currently.

If you want exposure to small caps it's much more efficient to own an index of small caps. Their performance has seriously lagged in recent times though, so just owning VOO has been the way to go for a long time.

Re: A critique of the claim that passive investing is a bubble

#188

Post by yborg » Thu, Sep 05, 2019, 11:11 PM UTC

dkarl wrote: post #155

christophilus wrote: post #141

Earlier quoted context omitted.

> Index fund investors are simply buying what the active investors have laid out for them. That works until it doesn't. If passive becomes big enough, the indices themselves will be the ones steering the ship. The active managers won't be significant enough to sway the indices. I heard this analogy on a podcast (I think it was Invest Like the Best): Indices are like a drunk person, and active managers are like the so…

As I understand it, the index funds aren't drunk and aimless, forced in a certain direction as a side effect of the trades of active investors. They are intentionally and methodically following the active investors.

Or the underlying companies that are traded.

This "evil zombie index fund" trope seems to imply that index managers just continue to blindly buy the stocks in the index regardless of events, falsely inflating the value of companies. If a company is unable to generate cashflow from its underlying business, this will quickly become evident because it will be unable to pay its creditors and employees. It could take advantage of its "inflated value" by issuing shares to generate cash, but this would then obviously begin diluting the stock and cause the price to fall, the "zombie indexes" wouldn't simply continue to price it at a constant value. I.e. price discovery will happen, just perhaps not as quickly as an active analyst monitoring the stock would do it.

Re: A critique of the claim that passive investing is a bubble

#189

Post by pas » Thu, Sep 05, 2019, 11:19 PM UTC

mox1 wrote: post #115

AlanYx wrote: post #110

Earlier quoted context omitted.

The "smart money" would start buying, but I imagine the concern is that as passive instruments become the majority of the market, there wouldn't be a deep enough pool of assets held by "smart money" to provide offsetting liquidity in the way you describe.

But wouldn't this reach some sort of equilibrium point? IE if a smart person with a lot of money think there is no "smart money" left, wouldn't (s)he just start their own smart money hedge fund to provide / do this? If nobody is left to do thing X AND thing X is basically guaranteed profit, isn't it natural for people to step in and do thing X?

But we already have that. Gold. Or CHF. The problem is that it takes roughly 10 years to outshine the stock market.

Re: A critique of the claim that passive investing is a bubble

#190

Post by pas » Thu, Sep 05, 2019, 11:28 PM UTC

hyperpape wrote: post #185

dcolkitt wrote: post #180

Earlier quoted context omitted.

No, I think in such a scenario active investors would wind up getting just as whalloped as passive investors. By definition active investors in aggregate have the same average exposure as cap-weighted indexers to any given stock. Arguably, after the crash they might be able to take advantage of the opportunity. If they concentrate into the stocks with the biggest price displacements, then as those stocks return to no…

I'm not sure I stated my question clearly enough. I'm not asking whether active funds would fare better than index funds in a downturn, though it's interesting to hear. I'm asking for a comparison of two scenariors. In the index fund scenario, we're in the world where index funds represent a large and growing chunk of the market. In the active funds scenario, index funds aren't a thing. Why is it that in the active f…

The difference is hypothetical, because if enough people exit the active fund, even if the fund manager thinks it's a folly, eventually they have to sell whatever makes up the fund, and eventually those sells will push prices down. That's why crashes are fast and hard.

Yes in theory the manager can try to alter the composition of the fund by selling the stocks that are still going strong. But why would they? That just exposes them to known hazards even more.

So, probably the active funds will be the first ones to drop the small stocks first in a crash.