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The Growing Peril of Index Funds: Too Much Tech

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

#11

Post by howlin »

brndnmtthws wrote: post #10
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…

This is not quite correct. There are other weighting methods (specifically, equal weighting) which would prevent this situation, whilst still remaining passive.

You would have to actively rebalance to keep equal weighting, so it is not as passive as typical market cap weighting.

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

#12

Post by statguy »

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…

I suspect we will reach an equilibrium where most people are indexing and a few very good active managers are in play, while most of the less competent managers have been booted out. There might be a few swings towards either side on the way to that steady state.

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

#13

Post by tomp »

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 price is set by the marginal investor, not by the average investor) is index funds, outperforming the market will be easier. In reality, you get a sensible balance.

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

#14

Post by brndnmtthws »

howlin wrote: post #11
brndnmtthws wrote: post #10

Earlier quoted context omitted.

This is not quite correct. There are other weighting methods (specifically, equal weighting) which would prevent this situation, whilst still remaining passive.

You would have to actively rebalance to keep equal weighting, so it is not as passive as typical market cap weighting.

You still have to rebalance market cap weighted funds, just much less so. Market cap weighted is indeed more efficient, but that's only assuming most stocks don't do things like pay dividends.

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

#15

Post by jameslk »

hendzen wrote: post #8
stcredzero wrote: post #2

Aren't there any broad non-tech index funds?

$SPXT (SPY-ex tech sector) would qualify, but it has almost no volume, so I would recommend against trading it. You could construct something roughly equivalent by going long x shares $SPY and then going short ~0.238 * x shares of $XLK.

I don't think shorting would be a very good strategy for passive, long term investors due to the associated costs (margin, dividend payments) and the unlimited risk.

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

#16

Post by hendzen »

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…

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.

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

#17

Post by brndnmtthws »

hendzen wrote: post #16
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…

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.

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

#18

Post by hendzen »

jameslk wrote: post #15
hendzen wrote: post #8

Earlier quoted context omitted.

$SPXT (SPY-ex tech sector) would qualify, but it has almost no volume, so I would recommend against trading it. You could construct something roughly equivalent by going long x shares $SPY and then going short ~0.238 * x shares of $XLK.

I don't think shorting would be a very good strategy for passive, long term investors due to the associated costs (margin, dividend payments) and the unlimited risk.

There isn't unlimited risk because the exposure to tech is hedged out by the opposing long/short positions (as are the dividend payments). Agreed that this isn't practical for the average investor though.

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

#19

Post by [deleted] »

hendzen wrote: post #18
jameslk wrote: post #15

Earlier quoted context omitted.

I don't think shorting would be a very good strategy for passive, long term investors due to the associated costs (margin, dividend payments) and the unlimited risk.

There isn't unlimited risk because the exposure to tech is hedged out by the opposing long/short positions (as are the dividend payments). Agreed that this isn't practical for the average investor though.

[deleted]

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

#20

Post by mcknz »

statguy wrote: post #12
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…

I suspect we will reach an equilibrium where most people are indexing and a few very good active managers are in play, while most of the less competent managers have been booted out. There might be a few swings towards either side on the way to that steady state.

The problem is that the pool of "few very good active managers" is changing all the time.

And if you happen to find an outperforming active manager, it's like buying high -- managers, like the market, always revert to the mean.

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