Does More Indexing Mean Less Stock Trading?

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SimpleGift
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Does More Indexing Mean Less Stock Trading?

Post by SimpleGift » Sat Feb 28, 2015 5:37 pm

Much has been written in the past few years about the fast-growing percentage of equity fund assets that is passively invested in index funds and ETFs (chart below). Their market share has grown to over 25% of U.S. equity funds and over 15% of global equity funds in the last 20 years. Many commentators have suggested that, as the percentage of passive equities grows beyond a certain threshold, stock markets will become much less efficient, due to insufficiently active share trading and price discovery.
However, a recent article by S&P Dow-Jones Indices points out that, even as the percentage of passive equities rises well above 50% of the market, the share of trading by active investors won't be appreciably diminished. The reason is the difference in turnover between active and passive management. In the chart below, it's assumed that passive equities have a 10% annual turnover rate, while active equities have a 100% turnover rate. If 70% of the market is eventually indexed, active managers will still be doing more than 80% of the trading, even assuming no increase in the number of active traders:
  • Image
    NOTE: Assumes that passive turnover rate is 10% annually and active turnover is 100%.
    Source: S&P Dow-Jones Indices
Bottom Line: It's the percentage of active trading, not the percentage of assets passively invested, that sets security prices. If active trading makes for an efficient market, then indexing has a VERY long way to go before market efficiency is affected — even with no new additional active traders entering the market.
Last edited by SimpleGift on Sat Feb 28, 2015 7:16 pm, edited 2 times in total.
Cordially, Todd

stlutz
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Re: Does More Indexing Mean Less Stock Trading?

Post by stlutz » Sat Feb 28, 2015 5:40 pm

It's also worth remembering that "index investing" and "buy-and-hold" are not the same thing. Many people use index funds as ways to time the market or various segments of the market (e.g. small vs. large, value vs. growth, industry X vs. industry Y etc.

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DonCamillo
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Re: Does More Indexing Mean Less Stock Trading?

Post by DonCamillo » Sat Feb 28, 2015 5:52 pm

If markets become less efficient, that means that people can make money by exploiting the inefficiencies. If that happens, active traders will come out of the woodwork to make an easy profit. As soon as they start to do that, market efficiency will go back up due to the price signals from the active trading.

Price signals are a key benefit from active trading. Traders think that company A might be overpriced and company B under-priced. So they sell A and buy B. The price of A goes down, the price of B goes up, and the market reaches equilibrium again.
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asif408
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Re: Does More Indexing Mean Less Stock Trading?

Post by asif408 » Sat Feb 28, 2015 7:24 pm

I'm not overly concerned about too many people indexing. There may be somewhat of a pendulum effect from time to time with markets being slightly more or slightly less efficient. However, human nature is greedy and insatiable and I don't foresee anything ever changing that.

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SimpleGift
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Re: Does More Indexing Mean Less Stock Trading?

Post by SimpleGift » Sat Feb 28, 2015 7:42 pm

Out of curiosity, I looked up a chart of trading volume for the S&P 500 over the past 25 years (below). It does appear that trading volume has decreased significantly since the 2000 tech run-up and crash, even as the market has gone on to reach new highs. I doubt the shrinking trading volume has much to do with indexing, but don't know enough about the market dynamics to understand the cause. What gives?

Image
Source: Wells Fargo

This makes me suspect (naively) that it doesn't take much trading volume to discover accurate prices.
Cordially, Todd

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k66
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Re: Does More Indexing Mean Less Stock Trading?

Post by k66 » Sun Mar 01, 2015 10:32 am

Simplegift wrote:
Image
Source: Wells Fargo
Yes interesting chart. I also wonder what the trading landscape was like pre2000. It seems as if the S&P500 is only now returning to earlier levels despite present-day HFT activity. Did the en masse day-trading movement of the late 90s really exceed the current hyperactivity of the Flash Boys?
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SteveB3005
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Re: Does More Indexing Mean Less Stock Trading?

Post by SteveB3005 » Sun Mar 01, 2015 11:09 am

The numerous types of index funds, value/growth, sector and size, collectively create many of the same push-pull trading dynamics that exist between active and passive managed funds now.

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nedsaid
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Re: Does More Indexing Mean Less Stock Trading?

Post by nedsaid » Sun Mar 01, 2015 11:47 am

One also has to factor the effect of people trading the indexes in ETF form.

For me, I buy and hold the indexes in both index fund and in ETF form. I do not trade these. So the amount of stock trading in my portfolio has decreased as I have indexed more.

For the market as a whole, more indexing might actually create more stock trading if professional traders trade the Index ETF's more and more. It is a tug of war between the long term investors and the traders. Who would have thought that the ultimate buy and hold invested would become a trading vehicle for professional traders?
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Texas Radio
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Re: Does More Indexing Mean Less Stock Trading?

Post by Texas Radio » Sun Mar 01, 2015 11:54 am

I am a buy and hold investor. Even so, when I was buying dividend growth stocks I would sell under certain circumstances. Since I've switched to index investing I fail to see any reason to sell. As such, my only "trades" now are buys.
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