too much money in indexes?

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petej
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too much money in indexes?

Post by petej » Mon Sep 07, 2015 5:52 am

Bogles. I've helped a few friends lately and pointed them to low-cost index funding. I usually get a handful of questions that are pretty simple to explain. But as with most topics, once in the role of teacher your own curiosity expands. So, I've had this looming question of my own that may be silly, but where better to ask.

I've seen articles lately talking about the massive shift investors have made into index funds - and indeed Vanguard. It seems to me that index funds would always work as data-driven models that proxy an actual index; which would work fine as long as index funds remained a minority of invested capital. But does it become a problem if more money seeks a proxy, than money that seeks to actually take individual company risks? I.e. - is it possible that so much market cap goes towards indexes that there's nothing to base an index reliably upon?

(forgive me if this is discussed previously, I searched but didn't see anything)

MKP
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Re: too much money in indexes?

Post by MKP » Mon Sep 07, 2015 6:07 am

The index buys shares in the underlying companies, it isn't just sitting in an account with Vanguard.

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in_reality
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Re: too much money in indexes?

Post by in_reality » Mon Sep 07, 2015 6:11 am

Others will have a more in depth answer but, here's mine:

I have some percent in fundamental indexes. It doesn't use market cap weighting.

So, if everyone else goes to 100% cap weighted, fundamental indexes and similar products would be setting the prices based on the companies fundamentals and performance.

In such a case, we'd (meaning fundamental index owners and market cap index owners) get exactly the same returns except I'd be paying higher fees.

Don't worry. I've got you covered. It's like buying someone a drink :sharebeer

We're a long way away from that though, so no need to say thanks.

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stevewolfe
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Re: too much money in indexes?

Post by stevewolfe » Mon Sep 07, 2015 6:33 am

I don't think there is any danger of everyone going 100% indexed. Just search here and see lots of folks using active funds like Wellington, Wellesley, short term investment grade, various stable value funds, etc. And not just from Vanguard as the are other funds mentioned here often from T. Rowe Price, Dodge and Cox, etc. :beer

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Re: too much money in indexes?

Post by sschullo » Mon Sep 07, 2015 6:41 am

Public School K-12 Educators: "Ask NOT what your annuity sales person can do for you, ask what you can do to be a Do-It-Yourselfer (DIY)."

lack_ey
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Re: too much money in indexes?

Post by lack_ey » Mon Sep 07, 2015 6:54 am

People talk about this all the time, but I wonder if it isn't a good thing that unsuccessful market players (dumb money?) turn to market cap weightings instead of contributing noise to market prices. Let the people who make the markets more efficient keep playing and get their reward for doing so. Most of the rest could largely back off.

petej
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Re: too much money in indexes?

Post by petej » Mon Sep 07, 2015 7:00 am

Thanks sschullo, those are great links!

In_reality, I hadn't heard of fundamental indexes. In theory, those could play the role of stock pickers/price setters in my theoretical bizarro-index-only world!

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in_reality
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Re: too much money in indexes?

Post by in_reality » Mon Sep 07, 2015 7:06 am

petej wrote:Thanks sschullo, those are great links!

In_reality, I hadn't heard of fundamental indexes. In theory, those could play the role of stock pickers/price setters in my theoretical bizarro-index-only world!
Schwab has them in their Robo-Advisory "Intelligent Portfolios". Some argue their slightly higher cost is dumb though.

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SimpleGift
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Re: too much money in indexes?

Post by SimpleGift » Mon Sep 07, 2015 8:51 am

petej wrote:is it possible that so much market cap goes towards indexes that there's nothing to base an index reliably upon?
Pete, it's not the percentage of market cap that is indexed or passively-managed that influences security prices, but rather the percentage of active trading.

In the chart below, it's assumed that passive equities have a 10% annual turnover rate, while active equities have a 100% turnover rate — both reasonable estimates based on past history. With these turnover rates, even if 70% of the market is eventually indexed (red circle), 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 passive turnover rate is 10% annually and active turnover is 100%.
    Source: S&P Dow-Jones Indices
Again, it's the percentage of active trading, not the percentage of assets passively-invested, that sets security prices.
Cordially, Todd

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telemark
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Re: too much money in indexes?

Post by telemark » Mon Sep 07, 2015 9:47 am

It's self-correcting. If the market becomes inefficient, that will create opportunities for stock pickers and active managers, and investors will move away from indexing, making the market more efficient again. Although if the past is any guide, they won't even wait that long. There are always people who think they can beat the market.

petej
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Re: too much money in indexes?

Post by petej » Sun Aug 20, 2017 1:27 pm

Original Poster here. Long time folks! Was pleased to see an article in the WSJ addressing my original concern! - better articulated of course. And, it does appear as if it is actually is a somewhat legitimate concern. I.e. - that maybe someday there won't be enough actives for passives to play off of.

https://www.wsj.com/articles/worlds-big ... 1502974668

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Phineas J. Whoopee
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Re: too much money in indexes?

Post by Phineas J. Whoopee » Sun Aug 20, 2017 3:23 pm

petej wrote:
Sun Aug 20, 2017 1:27 pm
Original Poster here. Long time folks! Was pleased to see an article in the WSJ addressing my original concern! - better articulated of course. And, it does appear as if it is actually is a somewhat legitimate concern. I.e. - that maybe someday there won't be enough actives for passives to play off of.

https://www.wsj.com/articles/worlds-big ... 1502974668
What if everybody indexed?
PJW

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patrick013
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Re: too much money in indexes?

Post by patrick013 » Sun Aug 20, 2017 4:12 pm

Indexing. Just organized buy-and-hold like investors are supposed
to be doing anyway. Valuing a stock is not only to estimate its fair value,
but also to determine its potential price range, taking into account
market behavior aspects. With a large volume of transactions, the
listed price will be close to the estimated fair value, or estimated price
range, like a confirmed rise. Some indexes trade a billion or more every
month. What is a large enough volume of transactions to ensure an efficient
price range ? With indexes buying and selling billions that adds to the
volume needed.

.02
age in bonds, buy-and-hold, 10 year business cycle

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Dale_G
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Re: too much money in indexes?

Post by Dale_G » Sun Aug 20, 2017 5:20 pm

When you see more than 50% active funds consistently beating an appropriate index after fees, the tide will turn . I will then join the active crowd. I don't see that happening anytime soon.

Dale
Volatility is my friend

Bacchus01
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Re: too much money in indexes?

Post by Bacchus01 » Sun Aug 20, 2017 9:49 pm

Dale_G wrote:
Sun Aug 20, 2017 5:20 pm
When you see more than 50% active funds consistently beating an appropriate index after fees, the tide will turn . I will then join the active crowd. I don't see that happening anytime soon.

Dale

If everyone indexed there would be no active trading. No active trading means no price changes. No price changes mean your returns are dividend based only.

While that's the extreme, it could end up muting returns.

McGilicutty
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Re: too much money in indexes?

Post by McGilicutty » Sun Aug 20, 2017 11:01 pm

Bacchus01 wrote:
Sun Aug 20, 2017 9:49 pm

If everyone indexed there would be no active trading. No active trading means no price changes. No price changes mean your returns are dividend based only.

While that's the extreme, it could end up muting returns.
I don't think that is what would happen. There would still be money flowing in and out of index funds, so there would still be price changes -- but they would just be proportional to the index.

In reality, there are tons of 'index' funds. The S&P 500 is the most well known, but there is the DOW 30, the Russell 2000, total stock market, midcap indexes, small cap indexes, and so on. Plus, there are all those sector ETFs.

I don't think indexing poses much of a threat to the stock market or the economy, but their low fees pose a threat to Wall Street fat cats' salaries, so we will continue to have posts and articles about the supposed 'dangers' of too much indexing.

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packer16
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Re: too much money in indexes?

Post by packer16 » Mon Aug 21, 2017 6:36 am

Simplegift wrote:
Mon Sep 07, 2015 8:51 am
petej wrote:is it possible that so much market cap goes towards indexes that there's nothing to base an index reliably upon?
Pete, it's not the percentage of market cap that is indexed or passively-managed that influences security prices, but rather the percentage of active trading.

In the chart below, it's assumed that passive equities have a 10% annual turnover rate, while active equities have a 100% turnover rate — both reasonable estimates based on past history. With these turnover rates, even if 70% of the market is eventually indexed (red circle), 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 passive turnover rate is 10% annually and active turnover is 100%.
    Source: S&P Dow-Jones Indices
Again, it's the percentage of active trading, not the percentage of assets passively-invested, that sets security prices.
I have heard this argument but have 2 issues I have not seen addressed. If someone has seen these addressed, I would like to know. First, while some of the volume is setting prices (buying securities that are priced cheaper than they are suppose to be) some of it is also momentum & trading like HFT. The former volume is what sets prices while latter adds noise. Given that HFT has high volume, what portion of that the volume we are observing is the value setting type versus the noise type?

Second, the movement into passive is taking from price setting volume directly while leaving noise volume unchanged. The result should be larger influence of noise volume vs. prices setting volume. What this will also do is make the rewards associated with active investing become more long term as the investors who would bid up cheap stocks are no longer there or are forced sellers as money is pulled from them.

Packer
Buy cheap and something good might happen

Bacchus01
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Re: too much money in indexes?

Post by Bacchus01 » Mon Aug 28, 2017 9:55 pm

McGilicutty wrote:
Sun Aug 20, 2017 11:01 pm
Bacchus01 wrote:
Sun Aug 20, 2017 9:49 pm

If everyone indexed there would be no active trading. No active trading means no price changes. No price changes mean your returns are dividend based only.

While that's the extreme, it could end up muting returns.
I don't think that is what would happen. There would still be money flowing in and out of index funds, so there would still be price changes -- but they would just be proportional to the index.

In reality, there are tons of 'index' funds. The S&P 500 is the most well known, but there is the DOW 30, the Russell 2000, total stock market, midcap indexes, small cap indexes, and so on. Plus, there are all those sector ETFs.

I don't think indexing poses much of a threat to the stock market or the economy, but their low fees pose a threat to Wall Street fat cats' salaries, so we will continue to have posts and articles about the supposed 'dangers' of too much indexing.
Why would money flowing in or out of an index fund have any impact on the price of the fund?

staybalanced
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Re: too much money in indexes?

Post by staybalanced » Tue Aug 29, 2017 1:15 pm

telemark wrote:
Mon Sep 07, 2015 9:47 am
It's self-correcting. If the market becomes inefficient, that will create opportunities for stock pickers and active managers, and investors will move away from indexing, making the market more efficient again. Although if the past is any guide, they won't even wait that long. There are always people who think they can beat the market.
Yes, +1

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flamesabers
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Re: too much money in indexes?

Post by flamesabers » Tue Aug 29, 2017 2:49 pm

petej wrote:
Sun Aug 20, 2017 1:27 pm
Original Poster here. Long time folks! Was pleased to see an article in the WSJ addressing my original concern! - better articulated of course. And, it does appear as if it is actually is a somewhat legitimate concern. I.e. - that maybe someday there won't be enough actives for passives to play off of.

https://www.wsj.com/articles/worlds-big ... 1502974668
As other have indicated, I think it's a self-correcting problem. If a particular sector or geographical area is having a sustaining economic boom, investors are going to gravitate towards it. Even brokerage firms like Vanguard offer a lot more then the simple 3-fund portfolio. The possibility of becoming rich by beating the market will always motivate some investors to engage in active trading, just as people continue to buy lottery tickets with the hope of winning the jackpot prize.

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