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Everytime one of these articles comes up, someone says, "but who will do price discovery, this is terrible"
What's the argument that active managers aren't just rent seeking parasites lying about their roles? Why have active fees gone down if they provided value all along?
> Everytime one of these articles comes up, someone says, "but who will do price discovery, this is terrible"
Note that this has been around since 1980:
> The Grossman-Stiglitz Paradox is a paradox introduced by Sanford J. Grossman and Joseph Stiglitz in a joint publication in American Economic Review in 1980[1] that argues perfectly informationally efficient markets are an impossibility since, if prices perfectly reflected available information, there is no profit to gathering information, in which case there would be little reason to trade and markets would eventually collapse.[2]
* https://en.wikipedia.org/wiki/Grossman-Stiglitz_Paradox
Paper:
* http://www.dklevine.com/archive/refs41908.pdf
* https://papers.ssrn.com/sol3/papers.cfm?abstract_id=228054
Price discovery happens at the edges: you probably don't need a lot activity for it. I think we're seeing a lot of the also-ran active managers (slowly) being weeded out, and the remainders will increasingly be those that actually manage to get things right every so often.
> What's the argument that active managers aren't just rent seeking parasites lying about their roles?
That someone has to set prices and structurally index funds can't do that job. How are prices going to be set without active participants? You could do it by formula I guess, but that would be gamed by companies around earnings time and doesn't account for differences in industries or differences in corporate strategy.
> Why have active fees gone down if they provided value all along?
That's exactly what you would expect as more firms enter providing the same service. The same thing happens in every other market. More competition drives down margins.
> What's the argument that active managers aren't just rent seeking parasites lying about their roles?
"That might be true of other active managers - not me though, this fund I manage has outperformed the market over the past 10 years."
If everyone invests in the sp500 then the price of the sp500 will climb, guaranteed, because you know that next months paychecks will purchase more of it.
You can’t really do anything about this even if you’re actively aware of this mechanism and think it’s fundamentally over valued.
It’s like a decentralized Ponzi scheme
There'll never be a shortage of people who think they can beat the market. Market beating is just such a compelling illusion. Also passive funds are not quite 100% passive. What does everyone do when they're broke? Stop investing. How about when times are good? Pile more into investments. There's also many different types of passive funds with slightly different biases. There's world passive funds (which have maybe 40% not in the S&P). There's passive funds that track other specific countries. There's ESG passive funds that avoid oil companies and such. There's passive that skips China. There's investor biases in there and prices being discovered all over.
> but who will do price discovery, this is terrible
Whoever actually believes they have more information than the market and is willing to stake their own money on the proposition. I'd guess that we need surprisingly few of those folks to keep the machinery humming.
You’re not considering that a lot of active managers are helping clients define bespoke investment strategies that suit their assets and liabilities. They set a strategy, pick a benchmark, and invest. In some cases, a portion of those investments may be passive instruments and other portions may be research-driven asset allocation by the manager.
Interest to revisit such militant attitudes should the current crash of inflated bullshit techcos continue.
Is your kids 529 plan on the S&P. Well congrats - you got to buy Tesla at the peak of Elon’s pump train just in time to be a ticket holder for his self-immolation show.
Does your 401k hold small cap exposure to the Russell. Yippee you get to be the bag holder for a good chunk of the SPAC garbage VCs dumped into public markets based on things like projections that personal electric helicopter taxis would become ubiquitous in US urban markets by 2025.
Passive investing got gamed by Silicon Valley and isn’t exactly what Bogle had in mind when he got started.
The arguement in both cases is that if someone is doing something useful in a market (like price discovery) they'll be paid according to how useful they are. And if their pay exceeds the cost then they'll profit. If not then your guy (or girl, or other descriptor) isn't useful and you're paying them from your picket. But it's your job to check and move your money accordingly. And you'll be paid for doing so, and penalised for not doing so.
If your active manager beats the index (in returns and risk) after fees then he is earning his keep both for you and the world in gen
Personally, I dont think price discovery is the biggest problem, but no overseight of the board of directors. Etf do not actively vote (as far as i understand). So this opens up for management and minority owners to run the comopany badly (or even plunder it). This is a negative effect in the long run though.
Well, we've kind of known that the benefits of active management would be diminishingly small. In theory they could be working just as hard, but at this point they are being paid to clip coupons that aren't there.
Price discovery just happens on a different pace mostly around earnings. But you’re still at the mercy of market makers which is a big problem on its own. We also have bonds/convertibles to help price securities.
The market does price discovery if it's not program traded.
What markets are doing is recording and publishing the results of auctions for the particular good as a time series of data. Indexes hide some of that but there's something far worse: HFT.
The problem is that program trading and HFT has far more in common with the old Scientific American COREWAR game than it does with the fundamentals of price discovery. The buy/sell decisions are about gaming other players rather than discovering price. There are also nonlinear feedback loops with very short loop time constants created that are "nonconservative" in a physics sense and create instablity. The fact that hard limits are required to deal with flash crashes is a warning, not a solution!!
Price discovery can be left to the prop traders.
Wouldn't fees go down as a result of more competition in the sector?
> "but who will do price discovery, this is terrible" - just rent seeking parasites lying about their roles
I think you copied and pasted your rant from a different rant about finance as it really doesnt have anything to do with this.
A clearer title (from the article) would be:
Retail investors’ holdings in index funds exceeds active funds for the first time
More specifically:
> As of March 31, Morningstar says, retail investors had $8.53 trillion invested in index mutual funds, while $8.34 trillion worth of assets were invested in actively-managed funds.
William F. Sharpe published the very short (two pages) article "The Arithmetic of Active Management" in 1991:
> Over any specified time period, the market return will be a weighted average of the returns on the securities within the market, using beginning market values as weights[3]. Each passive manager will obtain precisely the market return, before costs[4]. From this, it follows (as the night from the day) that the return on the average actively managed dollar must equal the market return. Why? Because the market return must equal a weighted average of the returns on the passive and active segments of the market. If the first two returns are the same, the third must be also.
> This proves assertion number 1. Note that only simple principles of arithmetic were used in the process. To be sure, we have seriously belabored the obvious, but the ubiquity of statements such as those quoted earlier suggests that such labor is not in vain.
> To prove assertion number 2, we need only rely on the fact that the costs of actively managing a given number of dollars will exceed those of passive management. Active managers must pay for more research and must pay more for trading. Security analysis (e.g. the graduates of prestigious business schools) must eat, and so must brokers, traders, specialists and other market-makers.
> Because active and passive returns are equal before cost, and because active managers bear greater costs, it follows that the after-cost return from active management must be lower than that from passive management.
* https://web.stanford.edu/~wfsharpe/art/active/active.htm
And on why picking a winning stock is so hard (first edition 1973):
* https://en.wikipedia.org/wiki/A_Random_Walk_Down_Wall_Street
But does it matter that the category of "active managers" achieves near-parity (after costs) with index funds if you're not able to maintain a running bet on the whole pool of active managers (i.e. you have to pick one or more specific managers)?
For instance, if today's active managers always lose their asses to new active managers arriving tomorrow, then any active manager you actually give your money to today is going to do way worse than an index fund, not just somewhat worse due to costs.
The set of active managers actually available at a given moment in time might be 100% long-term losers.
I’ve been something of a Boglehead for a long time, but every few years or so I try to look up analysis of active funds to try and see if they’re starting to beat the market as a whole.
I shouldn’t be surprised, but I can’t help always feeling a bit of surprise when the answer always ends up being “nope, only 10-20% of active managers are beating the market.”
So, if you’re going for actively managed funds, you’ve got a pretty low chance of actually picking a good one.
It’s no wonder index funds have now become the majority.
I have to admit that I don’t know enough about how the financial markets work to know what would happen if 100% of investors went with passive funds. How would that even work? Is that even possible?
Bogle himself talks about a bigger danger than price discovery etc - when all companies are owned by index funds effectively nobody owns them - and so they’ll be run by the managers for the managers.
http://johncbogle.com/wordpress/wp-content/uploads/2019/08/n...
It’s likely that we need to actually take ownership and not just let everything go as it goes forward.
It might be the case that we need to consider owning competitors an illegal conflict of interest, as if the whole market is majority owned by passive owners it's not so much a market of competitors as sibling subsidiaries.
my personal theory is that active management can still produce market-beating returns but the good active managers will rapidly grow their capital base to huge levels where they don't need much outside investment.
On the other hand - now we have a situation where most investment savings by individual investors are tracking passive indexes. But if everyone is indexing - what determines the relative weight of each stock in the index?
The answer is active investors. But with an increasingly smaller field of increasingly skilled investors (with more discretionary capital), we end up with the valuations of companies (and thus how societal time is allocated) competitively determined by a fierce prediction competition between the top active managers (Renaissance, DE Shaw, Citadel, etc).
I guess the big question how much active management is good. According to the article for funds it is now roughly 50%. I believe even 10% is plenty for market efficiency.
I was under the impression the relative weights are (often) simply proportional to their market cap. Afaict that's how that works for the sp500 at least.
Active managers make way more money selling their fund and increasing deposits than actually beating the market.
So they will do things like promote "downside protection", claiming that their returns will be close to Russel 2000, but 90% less likely to go down by 2x more than the Russel 2000 in any year. Which is bullshit because anyone could put 80% of their money in Russel 2000 and 10% in cash and 10% in gold and get the same guarantee without paying anyone for it.
Cash and gold are not the risk free rate.
All the things I’ve read about passive funds have pointed in the same general direction. I can completely buy the reasoning but I worry I’m missing part of the point, which brings me to my question.
In a scenario where passive funds are the best investment vehicle when looking at long term returns, what’s the role of buying and/or trading individual stocks?
Are there cases in which you’d prefer stocks over funds?
I’ve got some Netflix, Microsoft and Apple stock which I plan to keep for the long term. I could never figure out if that money would’ve been better spent as a fund purchase.
What trips me up is stocks tend to lead to bigger earnings (when things go right) and companies like Apple are almost certainly going to remain valuable for a long time.
What am I missing?
Edit: this has been a recurring theme in discussions I’ve had with my dad (who’s a financial advisor, ironically). I’ve pointed out to him that passive funds seem better but he keeps wanting to put my money into stocks, active funds or sometimes narrow, low(er) cost managed funds (e.g. biomedicine and robotics stuff).
> companies like Apple are almost certainly going to remain valuable for a long time
Based on what? At the end of the day, that's speculation. Who's to say Apple and other stocks you're holding won't suddenly stop beating the market?
It’s worth reading A Random Walk Down Wall Street. Most actively managed funds fare worse than passive ETFs over a large enough investment timeline.
Individual stocks are volatile and shouldn’t be used as the bulk of one’s retirement portfolio.
It’s all about risk analysis and mitigation.
> Are there cases in which you’d prefer stocks over funds?
They're more fun.
> What trips me up is stocks tend to lead to bigger earnings (when things go right)
Cryptocurrency investments also tend to bigger earnings when things go right.
The crux is the WHEN and IF you buy the right stock at the right time AND IF you sell it at the right time. Which most people cannot do consistently, meaning it's more up to luck than skill.
> I’ve pointed out to him that passive funds seem better but he keeps wanting to put my money into stocks, active funds or sometimes narrow, low(er) cost managed funds (e.g. biomedicine and robotics stuff).
Your dad sounds like a horrible financial advisor if that's the investment advice he's giving his customers.
> In a scenario where passive funds are the best investment vehicle when looking at long term returns, what’s the role of buying and/or trading individual stocks?
Just to be clear, there are two interpretations (possibly more) of “best” in your question:
* an index fund is “best” if its returns are greater than picking individual investments yourself.
* an index fund is “best” if it is the quickest/cheapest way to balance risk and reward over the long term.
I would guess that the majority of investors in index funds are looking for the quickest/cheapest approach.
If your appetite for risk is greater and you have some time available time to manage things yourself, you can certainly manage your own portfolio.
> what’s the role of buying and/or trading individual stocks?
Loads of reasons to do so:
1. You might have enough alpha to beat the returns of an index.
2.You prefer a more market neutral strategy and construct your own basket, maintaining it over various timescales.
The fact is that most of these reasons don't apply to your average retail investor though.
The financial markets are a fantastic ecosystem. There are all types of players out there: short-term vs long-term, high-frequency vs low-frequency, technical chart readers, fundamentals, macro, hedgers, punters, speculators, 401k managers, retirees, r/wsb, retail, institutional.
For as long as there have been markets, there are people who think they can beat them. So active management isn't going anywhere and it certainly wont disappear. There will certainly be a time when the active managers win out over passive.
On a related note: I have this particular view that most active managers inside trade. (Look at Steve Cohen, SAC/Point72 - the insider trading was rampant, and I assume that if it was this prevalent and the largest most sophisticated of funds - then its probably pretty pervasive). I think the SEC's continuous crackdown on systematic insider trading is partly responsible for the long decline of active management.
is technical chart reading real? does it really yield
any results?
Aside from costs, index funds may have outperformed because their share of the overtall pie has risen. If you consider an index fund to be an asset on its own, the price of that asset rises as more people invest in it. As a result, equities that are underrepresented in indices decrease on average, while those that are overrepresented - increase. We see evidence of this in the fact that equities tend to fall shortly after being removed from key indexes.
So index funds outperform because their share increases, and their share increases because they outperform. Classic bubble equation.
Are there index funds that are similar to hedge funds? I am looking for indices that generate returns that are uncorrelated to general market performance. Because that's what the hedge in hedge funds mean.
Yes and no. There are products that track hedge fund performance [0]. But ultimately these reflect active investment decisions, while a proper index fund does not
Some people use a emerging markets index for that, it's at least a little uncorrelated to western performance
I thought this was shown to be true in terms of expected ROI more than 25 years ago - it was talked about in my MBA program.
This is a macro phenomenon and will stop soon since the central bank has stopped printing money. Since 2008 major Central Banks are actively buying bonds in droves which companies use to buy back their stock and as a result increase prices of their stock. The passive strategy will not work anymore now because companies with high capital costs will get hammered.
I thought this was always true?
Index fund: https://en.wikipedia.org/wiki/Index_fund
> Comparison of index funds with index ETFs: In the United States, mutual funds price their assets by their current value every business day, usually at 4:00 p.m. Eastern time, when the New York Stock Exchange closes for the day. [40] Index ETFs, in contrast, are priced during normal trading hours, usually 9:30 a.m. to 4:00 p.m. Eastern time. Index ETFs are also sometimes weighted by revenue rather than market capitalization. [41]
Survivorship bias > Examples > In business, finance, and economics: https://en.wikipedia.org/wiki/Survivorship_bias
Its actually a very poorly written article, more clickbait than actually saying anything useful.
Case in point, title says "active managers" ...but if you read the article its actually "actively managed funds".
Which means that before we've started we're already deep into Apples & Oranges comparisons with "index funds" vs "actively managed funds".
"Index funds" are simple, they track an index. (oversimplified, there are technicalities, but we'll leave it at that).
"Actively managed funds" meanwhile have a defined remit, and each fund will have a different remit. They might be limited as to sectors, company size, market technicalities or anything else.
It is also likely the case that there is less interest in "actively managed funds" because if you are in the market for "actively managed" then you may well be constructing your own portfolio of individual equities rather than just buying a fund.
Furthermore, "index funds" can be used by money managers as part of a balanced portfolio. For example, they might pick individual equities in markets/sectors that they are familiar with, and then use index funds for broader geographical or other coverage.
So in essence the Yahoo article is a waste of words and is doing everyone a disservice, including the index funds it seeks to promote.
Most active funds are in fact mostly beta (indexed funds) with an exception of 5%.
Most articles are worthless, but it's hard for media outlets to say that nothing meaningful happened in their sector today.