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The ETF Files: How the U.S. government inadvertently launched a $3T industry

bloomberg.com

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Re: The ETF Files: How the U.S. government inadvertently launched a $3T industry

#21

Post by gcb0 »

Amorymeltzer wrote: post #3

Caught this story this morning on Bloomberg's Odd Lots podcast[1], it's a great story. The thread that stands out most to me (and to the hosts) is that here's a person who looks at an 840-page government report, reads it in-depth, and creates an industry. That's a feel-good outcome, of hard work others aren't willing to do. In a coincidence, perhaps, Planet Money's latest episode[2] dealt with Warren Buffet's bet on…

not really.

he built index funds just like before. he was just the first one to afford enough lawyers to launch a product that would be shut down by regulators because of 800 page conflicting regulations

Re: The ETF Files: How the U.S. government inadvertently launched a $3T industry

#22

Post by anonymousDan »

sparky_z wrote: post #6
Amorymeltzer wrote: post #3

Caught this story this morning on Bloomberg's Odd Lots podcast[1], it's a great story. The thread that stands out most to me (and to the hosts) is that here's a person who looks at an 840-page government report, reads it in-depth, and creates an industry. That's a feel-good outcome, of hard work others aren't willing to do. In a coincidence, perhaps, Planet Money's latest episode[2] dealt with Warren Buffet's bet on…

To be clear, the Warren Buffet bet was about index funds . Not all ETFs track index funds, and even the ones that do aren't necessary. You can just buy into the funds directly.

Can you clarify the difference between an index fund and an etf? I always thought they were synonymous.

Re: The ETF Files: How the U.S. government inadvertently launched a $3T industry

#23

Post by dne »

anonymousDan wrote: post #22
sparky_z wrote: post #6

Earlier quoted context omitted.

To be clear, the Warren Buffet bet was about index funds . Not all ETFs track index funds, and even the ones that do aren't necessary. You can just buy into the funds directly.

Can you clarify the difference between an index fund and an etf? I always thought they were synonymous.

ETF = investment fund traded on a stock exchange.

Index fund = investment fund (mutual fund or ETF) that tracks an index, i.e. passively managed.

Re: The ETF Files: How the U.S. government inadvertently launched a $3T industry

#24

Post by karmapolice »

anonymousDan wrote: post #22
sparky_z wrote: post #6

Earlier quoted context omitted.

To be clear, the Warren Buffet bet was about index funds . Not all ETFs track index funds, and even the ones that do aren't necessary. You can just buy into the funds directly.

Can you clarify the difference between an index fund and an etf? I always thought they were synonymous.

ETFs are just investment funds you can buy and sell in the stock market, with their own symbol and everything just like any other stocks.

Index (passive) funds track an index, instead of trying to outperform the market.

You can have passive funds that are not ETFs (do not appear as a symbol in the stock market, have to go through a bank or whatever to buy shares), and active funds that are ETFs (actively managed).

Re: The ETF Files: How the U.S. government inadvertently launched a $3T industry

#25

Post by stygiansonic »

Aside: The article mentions the "portfolio insurance" strategy and "program trading" as causes of the October 1987 crash. Basically, the portfolio insurance strategy was common in the 1980's and was typically implemented through program trading.

Portfolio insurance basically replicates a put option against some index, typically using index futures. The idea is that if you can't buy a put option against something, you can replicate it by creating a short position but you have adjust the size of the short position as the underlying price changes, aka a "dynamic hedge". Since the delta of a put option decreases as the price of the underlying falls, you have to short more (up to a point) when the price falls. There's nothing inherently wrong with this strategy.

However, if everyone (or a substantial portion of the market) is following this same strategy, it could be bad. This paper [1] reviews the commonly-point-to reasons for the October 1987 crash, and talks about program trading and the portfolio insurance strategy as potential causes, but also indicates that there were other issues at play. This other paper [2] looks at what happens when everyone, or substantially everyone, is following the same or similar strategy when it comes to portfolio management and/or trading strategies.

1. http://www.federalreserve.gov/pubs/feds/2007/200713/200713pa...

2. http://docs.lhpedersen.com/EveryoneRunsForExit.pdf

Re: The ETF Files: How the U.S. government inadvertently launched a $3T industry

#26

Post by lmm »

karmapolice wrote: post #24
anonymousDan wrote: post #22

Earlier quoted context omitted.

Can you clarify the difference between an index fund and an etf? I always thought they were synonymous.

ETFs are just investment funds you can buy and sell in the stock market, with their own symbol and everything just like any other stocks. Index (passive) funds track an index, instead of trying to outperform the market. You can have passive funds that are not ETFs (do not appear as a symbol in the stock market, have to go through a bank or whatever to buy shares), and active funds that are ETFs (actively managed).

Presumably any ETF is tracking something, that you could define to be an "index" in a degenerate sense (even if it's the "companies Buffet thinks are undervalued index", or the "solid gold bars index"). Or is there a technical definition of index?

Re: The ETF Files: How the U.S. government inadvertently launched a $3T industry

#27

Post by vostok »

eru wrote: post #20
emcq wrote: post #10

Earlier quoted context omitted.

Makes sense! You need to minimize tracking error on the underlying basket of assets, and the faster you are the less error you have.

emcq is sort-of right, that for buy-and-hold investors a small tracking error is OK, as long as it does not accumulate over time. But once you have the nice deposit/receipt system set up to incentivise people to trade the tracking error away with arbitrage, you get a smaller and smaller tracking error for free.

It is not obvious to me that the error would not accumulate. In fact, the opposite becomes somewhat clear if one looks at similar products that differ mainly in their lack of an arbitrage mechanism.

Re: The ETF Files: How the U.S. government inadvertently launched a $3T industry

#28

Post by xyzzy4 »

scottlocklin wrote: post #15
xyzzy4 wrote: post #13

Earlier quoted context omitted.

You can make even more money in the long run if you use leverage to bet on the S&P 500. If you don't believe me, do the math out.

I guess this is tautologically correct, but if you did a 2x levered punt on SPX in 2007, you'd have gone broke.

That's not true if you sell stock to maintain a certain equity to debt ratio. If you use leverage in the S&P 500 then you have much a faster growth rate, so in the long term it's still better.

Re: The ETF Files: How the U.S. government inadvertently launched a $3T industry

#29

Post by chiph »

I'm still skeptical of ETFs as I see them as being a derivative product - not trading the original shares, but tickets representing them. So I see the same dangers/risks with them as with mortgage-backed securities.

While I may be acting like an old fuddy-duddy, there is this:

>Of the 1,278 securities halted for trading, 80 percent involved ETFs, according to the SEC.

Re: The ETF Files: How the U.S. government inadvertently launched a $3T industry

#30

Post by mafribe »

chiph wrote: post #29

I'm still skeptical of ETFs as I see them as being a derivative product - not trading the original shares, but tickets representing them. So I see the same dangers/risks with them as with mortgage-backed securities. While I may be acting like an old fuddy-duddy, there is this: >Of the 1,278 securities halted for trading, 80 percent involved ETFs, according to the SEC.

    not trading the original shares,
That depends on the type of ETF. As far as I understand a "Physical ETF" does hold the securities of the index it follows. In contrast, "Synthetic ETFs" track an index using swaps and collateral.
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