lawman3966 wrote:Polar_Ice wrote:Allan Roth's reviewI do need to point out, Frontline, that you neglected to include a very critical segment in your documentary -- the vital role that active managers play. Seriously, who do you think keeps markets efficient and allows us indexers to profit? Without the expensive active managers, indexing wouldn't work.
I wish he would of explained this more. Maybe someone else can?
I will try. Allan appears to be saying that when the relative valuation of Exxon and IBM (for example) changes due to earnings or other factors, it is active traders who end up re-pricing the stock values of the companies to reflect their updated financial conditions. Indexers in theory can't do this because indexing inherently forces investors to buy both stocks or sell both stocks at the same time and to the same extent (that is, accordingly their respective weightings in the index).
Active traders may indeed perform the above needed function. But, active stock trading seems to me be different from active mutual fund account management. I think it oversells active mutual fund account management to suggest that such account managers perform the re-pricing function to keep the markets efficient. The re-pricing of components of the index occurs pretty much continuosly, given the microsecond trading that we now have. I just don't believe that most actively managed mutual funds trade with the level of frequency and precision needed for the pricing adjustment function. The active managers I've seen interviewed in the media seem to use some sort of macroeconomic logic to explain why their stock weightings depart from the weightings in the index.
I recall Bogle saying in one of his books that, in the aggregate, the totality of active fund managers are in fact indexers, just that they are high-fee indexers. This is because most stock shares are owned by active managers, and performance of the sum of all underlying assets of the various active managers is necessarily the same as that of the index as a whole. (However, the net performance is less than that of the index due to fees, taxes, and trading costs).
In sum, active stock trading does appear to be needed to adjust the pricing of stocks within the index. However, this observation, IMHO, bears little if any relevance to the fees charged by active mutual fund managers. Allan no doubt wishes to defend his industry. But, this particular argument doesn't work for me. If Allan wants to pay 2% of AUM annually to invest in the S&P 500, he's free to do so. But I will pass on that offer.
thanks lawman for your explanation. While I have heard this before that trading is what makes indexing work, I was surprised with Allan's defensivness. The market has 2.5 trillion in both VG and TIAA CREF. With this in mind, I wonder if Allan's prediction is correct, that indexes would already been affected. Thats a significant part of the market that is not traded daily and frequently. I think the key concept is frequent trading. Also, Allan said that in 20 years, trading will cease! Really, most retirees are trading now with distributions in retirement. Millions of workers are also trading while contributing. Millions of indexing investors may only trade to buy into the market and than trade to make distributions in retirement. Then there is rebalancing. Even with indexing, trading does not stop. The key is that we trade for a purpose other than trying to find the next gem that will make us rich. In my thinking, its not that the repricing will stop its that it will slow down as more and more people get into the indexing strategy. It can never stop for the above reasons.
In the end, as Mr. Bogle has said over and over, GDP, dividends and Corporate profits will go up over time and that is the only aspect of the stock market that we trust. If indexing is the strategy in 20 years, would contributions and distributions with rebalancing by millions of indexers be enough to reprice the stocks to keep markets efficient?