Impact of fleeing index investors on Index Mutual Funds: studies?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
User avatar
triceratop
Moderator
Posts: 3457
Joined: Tue Aug 04, 2015 8:20 pm
Location: la la land

Impact of fleeing index investors on Index Mutual Funds: studies?

Post by triceratop » Fri Oct 28, 2016 12:01 pm

Hi all,
I read in an op-ed today, which I'll decline to link to because it was primarily political in nature, that the S.E.C. may not properly understand the risks borne by index mutual fund investors if investors flee those funds en masse. The author additionally pointed out that investors may not understand the risks.

What could be referred to, here? My understanding is that mutual funds must post a NAV price once per day by the Investment Company Act of 1940. Is the problem that index managers may not be able to sell securities intra-day without hurting existing investors? What would the SEC's concerns be, and what might the author be referring to when mentioning that the SEC may be unaware of or unprepared for some risks? Further, what don't I understand about index mutual funds if many of my fellow shareholders of the mutual fund abandon ship?

I'd love to be referred to some academic studies that discuss these risks, as I dislike much of the fear-mongering that occurs in the popular press.

NB: I am not talking about thinly-traded ETFs having liquidity problems; let's assume for the purposes of this discussion I am talking only vanilla index mutual funds.

Thanks!
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

JoinToday
Posts: 664
Joined: Sat Mar 10, 2007 9:59 pm

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by JoinToday » Fri Oct 28, 2016 12:50 pm

I don't see the issue either.

If a bunch of people in the S&P 500 index fund sell, it seems like this would impact the price (no surprise), but it impacts the price for all investors of companies in the S&P 500, both index and non-index investors.

Regardless of whether it is intraday or only at the end of the day, I don't see what difference it would make, except that investors & fund managers won't be able to get out during the day if they can only trade after closing. But this is known to everyone.
I wish I had learned about index funds 25 years ago

Nekrotok
Posts: 97
Joined: Wed Aug 10, 2016 3:44 pm

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by Nekrotok » Fri Oct 28, 2016 1:22 pm

triceratop wrote:Hi all,
I read in an op-ed today, which I'll decline to link to because it was primarily political in nature, that the S.E.C. may not properly understand the risks borne by index mutual fund investors if investors flee those funds en masse. The author additionally pointed out that investors may not understand the risks.

What could be referred to, here?


I don't know. Did the author of the op-ed explain the risk? If they are accusing others of not understanding the risk, they should themselves be able to understand and explain what risk they are talking about.

The only concern I've heard of was around the unrealized capital gains in the mutual funds, but I couldn't see what the problem was.

User avatar
triceratop
Moderator
Posts: 3457
Joined: Tue Aug 04, 2015 8:20 pm
Location: la la land

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by triceratop » Fri Oct 28, 2016 1:28 pm

Nekrotok wrote:
triceratop wrote:Hi all,
I read in an op-ed today, which I'll decline to link to because it was primarily political in nature, that the S.E.C. may not properly understand the risks borne by index mutual fund investors if investors flee those funds en masse. The author additionally pointed out that investors may not understand the risks.

What could be referred to, here?


I don't know. Did the author of the op-ed explain the risk? If they are accusing others of not understanding the risk, they should themselves be able to understand and explain what risk they are talking about.

The only concern I've heard of was around the unrealized capital gains in the mutual funds, but I couldn't see what the problem was.


No, he did not. I wish he had, because I'd be able to do more research for myself into the specifics of his claim.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

lgs88
Posts: 210
Joined: Tue Jun 07, 2016 7:48 am

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by lgs88 » Fri Oct 28, 2016 2:13 pm

The author of that particular op-ed has skin in the active fund game. He is a director of the Sequoia Fund (SEQUX).

Image

I wonder whether his fund experienced difficulties liquidating assets at a fair price after their disastrous bet on Valeant Pharmaceuticals!
merely an interested amateur

afan
Posts: 2915
Joined: Sun Jul 25, 2010 4:01 pm

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by afan » Fri Oct 28, 2016 2:23 pm

I suspected as much. The article really meant "Please invest in my actively managed fund. PLEASE. Index funds have cooties."

If everyone bails out of stocks, as happens sometimes, people who are invested in stocks will suffer. People who hold individual stocks will suffer, people who hold active funds will suffer, people who hold index funds will suffer.

I think one might make an argument that the availability of options and futures on the indexes along with large investments in the indexes can contribute to sudden fast moves, down or up. Plus, many of the automated trading approaches focus on large aggregates of stocks, rather than individual stocks, so they may also move prices if they kick in.

But I don't know what the SEC is supposed to do about it or how it is supposed to "warn" investors. "News flash@! Stocks are volatile! Don't put the rent money in the stock market"??
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

User avatar
alec
Posts: 2834
Joined: Fri Mar 02, 2007 2:15 pm

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by alec » Fri Oct 28, 2016 2:36 pm

Maybe the funds could give the investors underlying stock instead of cash, just like the Sequoia fund did. :twisted:

http://www.wsj.com/articles/clients-pul ... 1460131047
"It is difficult to get a man to understand something, when his salary depends upon his not understanding it!" - Upton Sinclair

User avatar
nisiprius
Advisory Board
Posts: 33936
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by nisiprius » Fri Oct 28, 2016 2:38 pm

In the entire op-ed, the only discussion is the passing aside near the end,
Another: With retail investors flocking to index funds, does the agency fully understand the risks if investors should start to flee such funds en masse? And do investors understand the risks?
That's the sum total of everything he has to say about it.

This is standard FUD. Index funds, or at least cap-weighted index funds that include most of the market, are actually different from investments that commit to "betting" on one side or another. It hardly matters if investors pile in or pile out of index funds as such, provided they stay invested in the stock market. If every index fund investor bailed and bought active funds instead, the active funds would need to buy stocks to meet the demand, and would be very happy that the index funds were selling stocks to meet redemptions. The index funds would just be dumping into the market more of exactly what the market already has, in exactly the same mixture, in exactly the same balance.

You can think of a see-saw with investors on both sides of it. If investors on the south end see that the north end is up, and they all jump off the south end and climb onto the north end, eventually the see-saw tips, the north end falls and strikes the ground with a nasty bump.

Index fund investors are standing at the center, just above the pivot. They can jump on and off as much as they want to, and hardly affect the other riders at all.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

nominalBob
Posts: 99
Joined: Fri Nov 28, 2014 5:30 pm

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by nominalBob » Fri Oct 28, 2016 2:45 pm

If the funds are backed by ETFs such as IVV, VOO, SPY, then they are constituted and dissolved in "creation units" by the big boys doing arbitrage. Could that process be somehow disrupted?

Nekrotok
Posts: 97
Joined: Wed Aug 10, 2016 3:44 pm

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by Nekrotok » Fri Oct 28, 2016 2:50 pm

alec wrote:Maybe the funds could give the investors underlying stock instead of cash, just like the Sequoia fund did. :twisted:

http://www.wsj.com/articles/clients-pul ... 1460131047


Yeah, this article also mentions the unrealized capital gains as a factor as a problem for the fund in case there are mass withdrawals. Anybody know the actual math behind how this works and how in-kind redemption help the fund in this case? Somehow, the fund avoids realizing capital gains, but what about the investor who receives a bunch of stock? Does he end up with more than his share of capital gains on the in-kind redemption? How would the fund paying capital gains taxes come from the remaining investors instead of the guy who is making a withdrawal?
Last edited by Nekrotok on Fri Oct 28, 2016 3:03 pm, edited 1 time in total.

adamthesmythe
Posts: 1574
Joined: Mon Sep 22, 2014 4:47 pm

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by adamthesmythe » Fri Oct 28, 2016 2:52 pm

> If they are accusing others of not understanding the risk, they should themselves be able to understand and explain what risk they are talking about.

Picky, picky, picky.

I'm not sure how there would be a risk different from the risk of a surge of redemptions of any mutual fund.

User avatar
Taylor Larimore
Advisory Board
Posts: 25980
Joined: Tue Feb 27, 2007 8:09 pm
Location: Miami FL

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by Taylor Larimore » Fri Oct 28, 2016 2:55 pm

Impact of fleeing index investors on Index Mutual Funds?

triceratop

It seems to me that if investors flee total market index funds, there will be no securities left to invest in.

I suspect the writer ran out of something to write about.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

User avatar
triceratop
Moderator
Posts: 3457
Joined: Tue Aug 04, 2015 8:20 pm
Location: la la land

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by triceratop » Fri Oct 28, 2016 3:15 pm

nisiprius wrote:In the entire op-ed, the only discussion is the passing aside near the end,
Another: With retail investors flocking to index funds, does the agency fully understand the risks if investors should start to flee such funds en masse? And do investors understand the risks?
That's the sum total of everything he has to say about it.

This is standard FUD. Index funds, or at least cap-weighted index funds that include most of the market, are actually different from investments that commit to "betting" on one side or another. It hardly matters if investors pile in or pile out of index funds as such, provided they stay invested in the stock market. If every index fund investor bailed and bought active funds instead, the active funds would need to buy stocks to meet the demand, and would be very happy that the index funds were selling stocks to meet redemptions. The index funds would just be dumping into the market more of exactly what the market already has, in exactly the same mixture, in exactly the same balance.

You can think of a see-saw with investors on both sides of it. If investors on the south end see that the north end is up, and they all jump off the south end and climb onto the north end, eventually the see-saw tips, the north end falls and strikes the ground with a nasty bump.

Index fund investors are standing at the center, just above the pivot. They can jump on and off as much as they want to, and hardly affect the other riders at all.


Well the article was of course about something else entirely so I understood it going into detail about the SEC's responsibilities here. That said, yes I am aware of his conflicts of interest and disagreed with him.

But I assumed, perhaps falsely and naively, that there was some basis to make the claim as it is more specific than "active funds give you the possibility of outperformance".

Maybe I'll write a letter to the opinion editor asking them for pieces to be specific and not spread FUD.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

User avatar
Dale_G
Posts: 2939
Joined: Tue Feb 20, 2007 5:43 pm
Location: Central Florida - on the grown up side of 80

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by Dale_G » Fri Oct 28, 2016 3:27 pm

Investors fleeing index funds or actively managed funds doesn't matter. You can be sure that if investors are fleeing index funds, those invested in actively managed funds will do the same - or vice-versa.

Index funds were a much smaller fraction of the market on October 19, 1987. That didn't stop the S&P 500 from dropping 23% that day. It would likely have been a bigger drop if customers had been able to reach their brokers or mutual fund companies.

The SEC is right to be concerned about panics, but there is no reason to focus on broad based index funds. We now have "circuit breakers" and other mechanisms to deal with panic. Whether they will be enough is questionable.

Dale
Volatility is my friend

User avatar
JoMoney
Posts: 4319
Joined: Tue Jul 23, 2013 5:31 am

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by JoMoney » Fri Oct 28, 2016 3:38 pm

If we're talking about the un-linked Roger Lowenstein OpEd, where speaking about the SEC he says:
"With retail investors flocking to index funds, does the agency fully understand the risks if investors should start to flee such funds en masse? And do investors understand the risks?"

It's not clear that's he's saying anything at all. He puts a question mark at the end, and there's all sorts of dubious claims that get made in the form of question... trying to imply something, but not really saying anything that can be refuted. He asks a question, about whether or not some agency has asked a question... and I'd actually bet the answer is likely "yes, the SEC has looked at the impacts if investors start fleeing such funds in masse".

The article doesn't even narrow down the scope to what types of "index funds" he's looking at. There's been lots of news talking about the impacts of ETF's and on bond index funds that may not have the liquidity people expect in some circumstances. But it's really unclear what he's talking about.

As far as equity "index funds" go though, I would think the futures market on equity (and equity index) futures pose much bigger questions than that of mutual funds.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

User avatar
JoMoney
Posts: 4319
Joined: Tue Jul 23, 2013 5:31 am

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by JoMoney » Fri Oct 28, 2016 3:42 pm

JoMoney wrote:...I'd actually bet the answer is likely "yes, the SEC has looked at the impacts if investors start fleeing such funds in masse"...

SEC Proposes Liquidity Management Rules For Mutual Funds And ETFs
https://www.sec.gov/news/pressrelease/2015-201.html
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

User avatar
triceratop
Moderator
Posts: 3457
Joined: Tue Aug 04, 2015 8:20 pm
Location: la la land

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by triceratop » Fri Oct 28, 2016 3:46 pm

JoMoney wrote:If we're talking about the un-linked Roger Lowenstein OpEd, where speaking about the SEC he says:
"With retail investors flocking to index funds, does the agency fully understand the risks if investors should start to flee such funds en masse? And do investors understand the risks?"

It's not clear that's he's saying anything at all. He puts a question mark at the end, and there's all sorts of dubious claims that get made in the form of question... trying to imply something, but not really saying anything that can be refuted. He asks a question, about whether or not some agency has asked a question... and I'd actually bet the answer is likely "yes, the SEC has looked at the impacts if investors start fleeing such funds in masse".

The article doesn't even narrow down the scope to what types of "index funds" he's looking at. There's been lots of news talking about the impacts of ETF's and on bond index funds that may not have the liquidity people expect in some circumstances. But it's really unclear what he's talking about.

As far as equity "index funds" go though, I would think the futures market on equity (and equity index) futures pose much bigger questions than that of mutual funds.


Right, I was referring to the Lowenstein OpEd but didn't want to bring the politics of the SEC into this discussion.

And right, I follow Matt Levine's column (People are worried about bond market liquidity!), and I had assumed he'd sink his teeth into this juicy story if it was about anything more than this small slice of the markets. It's good to hear confirmation that this is FUD.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

dkturner
Posts: 1272
Joined: Sun Feb 25, 2007 7:58 pm

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by dkturner » Fri Oct 28, 2016 4:05 pm

JoMoney wrote:
JoMoney wrote:...I'd actually bet the answer is likely "yes, the SEC has looked at the impacts if investors start fleeing such funds in masse"...

SEC Proposes Liquidity Management Rules For Mutual Funds And ETFs
https://www.sec.gov/news/pressrelease/2015-201.html


The liquidity proposals contained in this SEC proposed rule might create problems for very large index funds, which typically hold minimal cash cushions. I believe in the early days of the Vanguard Emerging Markets Index Fund it held a constant cash reserve - and modified the performance of its tracking index by including the impact of the cash reserve on the index as well as the fund. Vanguard may have to consider doing something like this in the future for its other large index funds.

lgs88
Posts: 210
Joined: Tue Jun 07, 2016 7:48 am

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by lgs88 » Fri Oct 28, 2016 4:10 pm

Note also that Vanguard recently increased their credit line to $3 billion "in order to meet emergency redemption requests". Whether they'd actually be able to draw on it in a crisis, I do not know. It is worth noting that it is a little less than 1/1000 of their total AUM, so presumably it's not designed to staunch a pell-mell "run on the bank" type situation.

https://www.ft.com/content/b31843e8-81a ... 7211ef3198
merely an interested amateur

FillorKill
Posts: 1007
Joined: Sat Aug 06, 2011 7:01 am

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by FillorKill » Fri Oct 28, 2016 4:35 pm

triceratop wrote:...that the S.E.C. may not properly understand the risks borne by index mutual fund investors if investors flee those funds en masse. The author additionally pointed out that investors may not understand the risks.


"the reality is that mutual funds are ultimately owned by tens of millions of individual investors, each with their own time horizons, risk preferences, and investment goals. Even under the most stressful market conditions, our experience is wholly inconsistent with the conjecture that mutual funds are susceptible to mass redemptions. Mutual fund investors simply are not inclined to redeem during times of market stress.... In fact, in the history of the mutual fund industry, a run on equity and bond funds has never materialized...

For example, during October 1987, when the S&P 500 Index returned –21.5%, stock fund investors made net redemptions totaling about 3% of stock fund assets. From October 31, 2007, to February 27, 2009, the S&P 500 Index returned –50.9%, the worst stock market decline since the Great Depression. Over this same period, investors redeemed a net $281 billion from equity mutual funds, which represented a mere 4.1% of equity assets under management measured from the start of the period".

^ That's from a letter from Vanguard to the FSOC written in early '15 [attached] you may find it interesting.

https://pressroom.vanguard.com/content/ ... 5.2015.pdf

User avatar
triceratop
Moderator
Posts: 3457
Joined: Tue Aug 04, 2015 8:20 pm
Location: la la land

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by triceratop » Fri Oct 28, 2016 4:56 pm

FillorKill wrote:
triceratop wrote:...that the S.E.C. may not properly understand the risks borne by index mutual fund investors if investors flee those funds en masse. The author additionally pointed out that investors may not understand the risks.


"the reality is that mutual funds are ultimately owned by tens of millions of individual investors, each with their own time horizons, risk preferences, and investment goals. Even under the most stressful market conditions, our experience is wholly inconsistent with the conjecture that mutual funds are susceptible to mass redemptions. Mutual fund investors simply are not inclined to redeem during times of market stress.... In fact, in the history of the mutual fund industry, a run on equity and bond funds has never materialized...

For example, during October 1987, when the S&P 500 Index returned –21.5%, stock fund investors made net redemptions totaling about 3% of stock fund assets. From October 31, 2007, to February 27, 2009, the S&P 500 Index returned –50.9%, the worst stock market decline since the Great Depression. Over this same period, investors redeemed a net $281 billion from equity mutual funds, which represented a mere 4.1% of equity assets under management measured from the start of the period".

^ That's from a letter from Vanguard to the FSOC written in early '15 [attached] you may find it interesting.

https://pressroom.vanguard.com/content/ ... 5.2015.pdf



The op-ed wasn't talking about risks during an equity crisis, in my opinion. He seemed to be opining on the possibility that index investors would bolt from passive to active funds at a particular juncture (why?) just as they have from active funds. But, thank you for the link.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

User avatar
nisiprius
Advisory Board
Posts: 33936
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by nisiprius » Fri Oct 28, 2016 5:06 pm

JoMoney wrote:
JoMoney wrote:...I'd actually bet the answer is likely "yes, the SEC has looked at the impacts if investors start fleeing such funds in masse"...

SEC Proposes Liquidity Management Rules For Mutual Funds And ETFs
https://www.sec.gov/news/pressrelease/2015-201.html
Just to be clear, that's a result of perceived problems in bond funds, particularly bond funds that invest in low-credit-quality corporates.

In general, if there aren't any liquidity problems--and I don't think there are in any stocks in the S&P 500--then investors fleeing a fund is bad for the fund company, but no big deal for anyone else, including the investors remaining in the fund. As I've pointed out, the PIMCO Total Return Fund was once the largest mutual fund in the world, and when Bill Gross left, over the next few years it experienced massive outflows amounting to $200 billion dollars, reducing it to 1/3 of its peak size, with no obvious problems either for the fund or for competitors that investors flooded into.

And according to what I've read, the possibility of massive redemptions was an important consideration when the Investment Company Act of 1940 was written, which is one of the reasons why mutual funds have many constraints on them, particularly with respect to liquidity.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

User avatar
David Jay
Posts: 3891
Joined: Mon Mar 30, 2015 5:54 am
Location: Michigan

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by David Jay » Fri Oct 28, 2016 5:41 pm

triceratop wrote:
FillorKill wrote:
triceratop wrote:...that the S.E.C. may not properly understand the risks borne by index mutual fund investors if investors flee those funds en masse. The author additionally pointed out that investors may not understand the risks.


"the reality is that mutual funds are ultimately owned by tens of millions of individual investors, each with their own time horizons, risk preferences, and investment goals. Even under the most stressful market conditions, our experience is wholly inconsistent with the conjecture that mutual funds are susceptible to mass redemptions. Mutual fund investors simply are not inclined to redeem during times of market stress.... In fact, in the history of the mutual fund industry, a run on equity and bond funds has never materialized...

For example, during October 1987, when the S&P 500 Index returned –21.5%, stock fund investors made net redemptions totaling about 3% of stock fund assets. From October 31, 2007, to February 27, 2009, the S&P 500 Index returned –50.9%, the worst stock market decline since the Great Depression. Over this same period, investors redeemed a net $281 billion from equity mutual funds, which represented a mere 4.1% of equity assets under management measured from the start of the period".

^ That's from a letter from Vanguard to the FSOC written in early '15 [attached] you may find it interesting.

https://pressroom.vanguard.com/content/ ... 5.2015.pdf



The op-ed wasn't talking about risks during an equity crisis, in my opinion. He seemed to be opining on the possibility that index investors would bolt from passive to active funds at a particular juncture (why?) just as they have from active funds. But, thank you for the link.


"Why?" ...that, detective, is the right question.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

rrppve
Posts: 795
Joined: Sun Aug 12, 2012 12:35 am

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by rrppve » Fri Oct 28, 2016 5:45 pm

While I'm not particularly worried about this risk, there is a huge difference in the liquidity of the individual stocks in an S&P 500 index fund, compared to a small cap or emerging market fund.
The risk is the standard one that under stress the fund manager sells the most liquid issues leaving the fund slightly out of balance and overweighted in lower liquidity issues for which spreads have widened and a true price to sell a large quantity is unknown. The remaining investors suffer, while the exiting investors benefit from this, at least temporarily.
DFA which claims to benefit from this in normal times would face this issue with their micro-cap fund consisting of the lowest 20% of stocks by market cap should it ever come under pressure. Wonder how it behaved when the markets reopened after 9/11 or Lehman's crash.

User avatar
JoMoney
Posts: 4319
Joined: Tue Jul 23, 2013 5:31 am

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by JoMoney » Fri Oct 28, 2016 6:15 pm

nisiprius wrote:
JoMoney wrote:
JoMoney wrote:...I'd actually bet the answer is likely "yes, the SEC has looked at the impacts if investors start fleeing such funds in masse"...

SEC Proposes Liquidity Management Rules For Mutual Funds And ETFs
https://www.sec.gov/news/pressrelease/2015-201.html
Just to be clear, that's a result of perceived problems in bond funds, particularly bond funds that invest in low-credit-quality corporates.

In general, if there aren't any liquidity problems--and I don't think there are in any stocks in the S&P 500--then investors fleeing a fund is bad for the fund company, but no big deal for anyone else, including the investors remaining in the fund. As I've pointed out, the PIMCO Total Return Fund was once the largest mutual fund in the world, and when Bill Gross left, over the next few years it experienced massive outflows amounting to $200 billion dollars, reducing it to 1/3 of its peak size, with no obvious problems either for the fund or for competitors that investors flooded into.

And according to what I've read, the possibility of massive redemptions was an important consideration when the Investment Company Act of 1940 was written, which is one of the reasons why mutual funds have many constraints on them, particularly with respect to liquidity.

The reaction was to issues / headlines discussing problems with low quality bond funds, but it looks like the impacts and things looked at by the SEC considered all mutual funds.
All I was trying to get at though, is that in answer to the OpEd articles question, it appears that "Yes" the SEC has looked at it
Not an easy read, but there's some interesting information and footnotes in this SEC paper
https://www.sec.gov/rules/final/2016/33-10233.pdf
See, e.g., FSR Comment Letter (“[T]he Commission should consider alternative regulatory approaches for
index funds that seek to track the performance of indices that are comprised of highly liquid assets….”);
Dechert Comment Letter (citing Statement on Open-End Fund Liquidity Risk Management Programs and
Swing Pricing, Commissioner Daniel M. Gallagher, Securities and Exchange Commission (Sept. 22, 2015)
(“Furthermore, for funds that invest solely in assets that can be settled in three days or less – for example, a
fund that limits its investments to equity securities of S&P 500 companies – the ‘three-day bucket’ has no
functional value. Requiring such a fund to set its three-day bucket – whether it be at 1%, or 20% or even
90% – would be a meaningless exercise given that the entire portfolio would be comprised of assets settled
in three days or less.”
)).
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

Geologist
Posts: 1096
Joined: Fri Jan 02, 2009 7:35 pm

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by Geologist » Fri Oct 28, 2016 7:01 pm

Nekrotok wrote:
alec wrote:Maybe the funds could give the investors underlying stock instead of cash, just like the Sequoia fund did. :twisted:

http://www.wsj.com/articles/clients-pul ... 1460131047


Yeah, this article also mentions the unrealized capital gains as a factor as a problem for the fund in case there are mass withdrawals.


I'm a little unclear on why, in most cases, there would be mass withdrawals unless stock prices fell. In that case, the unrealized capital gains of an index fund would also be disappearing. Then the question of how it would be a problem for the fund or its shareholders would be diminished. I assumed that Sequoia ran into mass withdrawals because investors lost confidence in its active management strategies. That would hardly be an issue with an index fund.

jalbert
Posts: 2162
Joined: Fri Apr 10, 2015 12:29 am

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by jalbert » Fri Oct 28, 2016 7:04 pm

Seems like we would see the same problem if a large contingent of investors fled active stock funds en masse. Oh wait, they already did that.

User avatar
czeckers
Posts: 927
Joined: Thu May 17, 2007 3:49 pm
Location: Upstate NY

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by czeckers » Fri Oct 28, 2016 7:04 pm

For every seller there must be a buyer. If investors flee funds en masse, then other investors must be buying en masse as well.

To be fair, you will get panics every now and then. Generally speaking, the investors who held on, or better yet, those who had the foresight and resources to load up on shares during the panic ended up doing well. Those who jumped to the side lines did not.

So in the end, there will be some losers, and some winners.
The Espresso portfolio: | | 16% LCV, 16% SCV, 16% EM, 8% Int'l Value, 8% Int'l Sm, 8% US REIT, 8% Int'l REIT, 20% Inter-term US Treas | | "A journey of a thousand miles begins with a single step."

User avatar
triceratop
Moderator
Posts: 3457
Joined: Tue Aug 04, 2015 8:20 pm
Location: la la land

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by triceratop » Fri Oct 28, 2016 9:44 pm

rrppve wrote:While I'm not particularly worried about this risk, there is a huge difference in the liquidity of the individual stocks in an S&P 500 index fund, compared to a small cap or emerging market fund.
The risk is the standard one that under stress the fund manager sells the most liquid issues leaving the fund slightly out of balance and overweighted in lower liquidity issues for which spreads have widened and a true price to sell a large quantity is unknown. The remaining investors suffer, while the exiting investors benefit from this, at least temporarily.
DFA which claims to benefit from this in normal times would face this issue with their micro-cap fund consisting of the lowest 20% of stocks by market cap should it ever come under pressure. Wonder how it behaved when the markets reopened after 9/11 or Lehman's crash.


This is why DFA has their funds sold by advisors who ensure that investors don't sell in a downturn out of panic; it (supposedly, according to their marketing team) allows them to deliver the better returns to their investors. There's some doubt whether this is as important in US markets anymore.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

FillorKill
Posts: 1007
Joined: Sat Aug 06, 2011 7:01 am

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by FillorKill » Sun Oct 30, 2016 10:12 am

triceratop wrote:Further, what don't I understand about index mutual funds if many of my fellow shareholders of the mutual fund abandon ship?

Nothing. You get your pro rata share of gains and losses just like everyone else with similar exposure be that through a fund pursuing the same objective, holding the underlying securities, etc. If you mean what happens to a particular fund in the face of exceptionally large redemptions then there are a few tools used to ensure fund assets are priced/disposed of at FMV:

1. The fund has up to seven days to pay the proceeds from redemptions to investors
2. The fund reserves the right to redeem in-kind
3. In an emergency situation where it is not practical to dispose of securities or determine FMV then special relief from the SEC to temporarily suspend redemptions or delay payment of redemption proceeds further than 7 days is available.

But who knows, maybe I just keep misinterpreting your questions. :P

User avatar
Barry Barnitz
Wiki Admin
Posts: 2963
Joined: Mon Feb 19, 2007 10:42 pm
Contact:

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by Barry Barnitz » Sun Oct 30, 2016 5:32 pm

HI:

Recent article from etf.com. ----> Dave Nadig's Deep Dive On New ETF Liquidity Rules

There are two groups that have an immediate problem. The first is ETFs that invest in less liquid securities. Funds that invest primarily in high-yield debt or bank loans may be able to argue that they can unload their whole portfolios without impact, but ultimately fund boards will have to decide how much risk they want to take in defining liberal interpretations of “illiquid.”

The second issue is large funds. Because there’s no scaling here, funds that are very large have a much higher burden than small funds. I can own 100 shares of the most illiquid microcap and probably claim correctly that I could find a buyer in week. Not so for a $100 billion fund trying to own a proportionally similar position in the same company.

This second issue is a big one, particularly for Vanguard. Vanguard’s ETFs are share classes of mutual funds. My assumption is that the root fund is what will have to make the test, not each individual share class, so it won’t get the pass on the reporting or highly liquid requirements. And Vanguard will be hit harder on the 15% illiquid cap than it would if its ETFs were in fact separate funds.

While most of Vanguard’s 70 ETFs are in highly liquid corners of the market, it’s possible that funds like the Vanguard Small Cap Index Fund (VB) or the Vanguard Short Term Corporate Bond Index Fund (VCSH) could face real hurdles. When I ran the volume numbers on VCSH holdings last year, I estimated that even swamping the market, it would take VCSH 16 days to trade out.

So without market impact, that’s probably a multiple—clearly a fund that probably won’t be in compliance without a pretty liberal interpretation of how the short-term corporate markets can absorb big sales.

Could Vanguard solve this problem? It would be tricky. It would need to spin the ETFs out and adopt full disclosure. That’s a lot of work to save a few funds. Then again, I’m not sure what the options are.

In the end, it does seem like ETFs dodged a BB here, if not a bullet, but the ripples from this earthquake will be felt for quite some time. I’m not suggesting we’ll see a huge raft of fund closures, but at a minimum, it’s a good year to be a lawyer advising fund boards


regards,
Image | blb | December Birthday Celebration: Ludwig van Beethoven

User avatar
triceratop
Moderator
Posts: 3457
Joined: Tue Aug 04, 2015 8:20 pm
Location: la la land

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by triceratop » Sun Oct 30, 2016 5:42 pm

Barry Barnitz wrote:HI:

Recent article from etf.com. ----> Dave Nadig's Deep Dive On New ETF Liquidity Rules

There are two groups that have an immediate problem. The first is ETFs that invest in less liquid securities. Funds that invest primarily in high-yield debt or bank loans may be able to argue that they can unload their whole portfolios without impact, but ultimately fund boards will have to decide how much risk they want to take in defining liberal interpretations of “illiquid.”

The second issue is large funds. Because there’s no scaling here, funds that are very large have a much higher burden than small funds. I can own 100 shares of the most illiquid microcap and probably claim correctly that I could find a buyer in week. Not so for a $100 billion fund trying to own a proportionally similar position in the same company.

This second issue is a big one, particularly for Vanguard. Vanguard’s ETFs are share classes of mutual funds. My assumption is that the root fund is what will have to make the test, not each individual share class, so it won’t get the pass on the reporting or highly liquid requirements. And Vanguard will be hit harder on the 15% illiquid cap than it would if its ETFs were in fact separate funds.

While most of Vanguard’s 70 ETFs are in highly liquid corners of the market, it’s possible that funds like the Vanguard Small Cap Index Fund (VB) or the Vanguard Short Term Corporate Bond Index Fund (VCSH) could face real hurdles. When I ran the volume numbers on VCSH holdings last year, I estimated that even swamping the market, it would take VCSH 16 days to trade out.

So without market impact, that’s probably a multiple—clearly a fund that probably won’t be in compliance without a pretty liberal interpretation of how the short-term corporate markets can absorb big sales.

Could Vanguard solve this problem? It would be tricky. It would need to spin the ETFs out and adopt full disclosure. That’s a lot of work to save a few funds. Then again, I’m not sure what the options are.

In the end, it does seem like ETFs dodged a BB here, if not a bullet, but the ripples from this earthquake will be felt for quite some time. I’m not suggesting we’ll see a huge raft of fund closures, but at a minimum, it’s a good year to be a lawyer advising fund boards


regards,


This is excellent. Thank you very much, Barry.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

heyyou
Posts: 2718
Joined: Tue Feb 20, 2007 4:58 pm

Re: Impact of fleeing index investors on Index Mutual Funds: studies?

Post by heyyou » Mon Oct 31, 2016 1:15 pm

FUD: fear, uncertainty, and doubt

Post Reply