Index funds is the reason for overvalued market

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misterno
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Index funds is the reason for overvalued market

Post by misterno » Mon Dec 19, 2016 11:50 am

Says hedge fund manager Bill Ackma

http://www.pragcap.com/dear-hedge-funds ... r-returns/

What do you think?

corysold
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Re: Index funds is the reason for overvalued market

Post by corysold » Mon Dec 19, 2016 11:51 am

I think he has failed to out perform the market and is looking for an excuse.

Rodc
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Re: Index funds is the reason for overvalued market

Post by Rodc » Mon Dec 19, 2016 12:06 pm

Ackman and other hedge funds would do better by their shareholders if they reduced their fees rather than blaming low fee index funds for their inability to identify pockets of the market that will generate better returns.
Not likely to happen unless forced because investors pull out or somehow increased competition from low cost but successful hedge funds comes on line.

For the most part indexing simply follows the prices set by active investors, including high frequency traders. At very high participation, in dollars, I supposed indexing could have an influence, but mostly trades are just one higher frequency trader to another (perhaps not a true high freq trader, but some much more active trader than an index fund).
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

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Re: Index funds is the reason for overvalued market

Post by McGilicutty » Mon Dec 19, 2016 12:10 pm

I think anyone who invests in a hedge fund, with their 2% of principal and 20% of gains fees, is a fool. Ackman is looking for more fools.

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Re: Index funds is the reason for overvalued market

Post by rbaldini » Mon Dec 19, 2016 12:20 pm

Is the market overvalued?

Gropes & Ray
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Re: Index funds is the reason for overvalued market

Post by Gropes & Ray » Mon Dec 19, 2016 12:28 pm

I think Ackman might have a point about the effects of indexing on corporate governance; the jury is still out on that. But that really has nothing to do with hedge funds.

Also, if indexers are just blindly buying every company without regard for profit expectations (which is true, I think), there should still be a traders' market. Some companies are going to do better than others.
Last edited by Gropes & Ray on Mon Dec 19, 2016 12:42 pm, edited 1 time in total.

lack_ey
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Re: Index funds is the reason for overvalued market

Post by lack_ey » Mon Dec 19, 2016 12:35 pm

First of all, this claim from Bill Ackman (Pershing Square, which has had a good record overall by luck and/or skill, hence why anybody cares who an Ackman is) was from a while ago, like the beginning of the year, back when he was still taking flak from his stake in Valeant Pharmaceuticals. The linked article taking offense to it is from January this year.

rbaldini wrote:Is the market overvalued?
Naturally, active investors, particularly discretionary active "superstar" managers have opinions on these things and for reasons XYZ he believed then that it was overvalued.

Objectively speaking, by a number of measures (but there are many more and some disagree), the market is highly valued, particularly in the context of history and relatively speaking if looking at the US compared to elsewhere*. I'm not particularly a great fan of the historical comparison as there's no real reason for these things to track historical averages. Overvalued implies that it's too high, not just high. That cannot with certainty ever be answered, given that we only get to see one outcome for every given situation, but allowing some reasonable level of uncertainty and subjective impression can sometimes be answered satisifactorily in the future. For example few in hindsight would consider Japan in 1990 not overvalued. Ex-ante you can make a case one way or the other, and that's certainly within an active manager's prerogative, but you can't definitively substantiate or refute the claim.

*this in absolute terms, as well as by historical percentile, i.e. US at X percentile, others at A / B / C / D percentile where X > A, X > B, X > C, X > D, etc.

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Re: Index funds is the reason for overvalued market

Post by larryswedroe » Mon Dec 19, 2016 12:37 pm

indexers are price accepters, it's the active managers that are setting the prices, not the passive ones
Larry

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Raymond
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Re: Index funds is the reason for overvalued market

Post by Raymond » Mon Dec 19, 2016 12:43 pm

misterno wrote:...What do you think?
I think I hear the world's smallest violin playing :P

I guess an upgrade from his present Gulfstream G550 will have to be delayed.
"Ritter, Tod und Teufel"

RAchip
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Re: Index funds is the reason for overvalued market

Post by RAchip » Mon Dec 19, 2016 12:49 pm

If a greater and greater percent of the money entering the market does so via index funds, wont that create opportunities for individual stock pickers? If lots of money mobes in and out via indexes, thats a lot of buying and selling without reference to what is actually happening to individual companies.

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Re: Index funds is the reason for overvalued market

Post by rbaldini » Mon Dec 19, 2016 12:50 pm

lack_ey wrote:
rbaldini wrote:Is the market overvalued?
Naturally, active investors, particularly discretionary active "superstar" managers have opinions on these things and for reasons XYZ he believed then that it was overvalued.

Objectively speaking, by a number of measures (but there are many more and some disagree), the market is highly valued, particularly in the context of history and relatively speaking if looking at the US compared to elsewhere*. I'm not particularly a great fan of the historical comparison as there's no real reason for these things to track historical averages. Overvalued implies that it's too high, not just high. That cannot with certainty ever be answered, given that we only get to see one outcome for every given situation, but allowing some reasonable level of uncertainty and subjective impression can sometimes be answered satisifactorily in the future. For example few in hindsight would consider Japan in 1990 not overvalued. Ex-ante you can make a case one way or the other, and that's certainly within an active manager's prerogative, but you can't definitively substantiate or refute the claim.
Thanks. I guess it's hard for me to say whether something is overvalued when I haven't seen a precise definition of "overvalued" in the first place.

I suppose one can define an overvalued good as one that does not return "enough" utility per price. What would "not enough" mean? I suppose if it's intended to return wealth, "not enough" would mean either the return is less than the cost or, more generally, less than an alternative - because then a rational wealth maximizer wouldn't be buying it (well, unless it helps to diversify, etc - part of your utility function could be low volatility, etc). Applying this is hard because it would require us to know how much stock is going to return in the future, which of course we don't. If you believe the market is strictly a random walk with no predictive variables, then the expected return to stock is always the same, so it's impossible for it to be overvalued, right? (Except in hindsight, which is useless.)

In contrast, I don't think a good definition of "overvalued" is "prices are higher per earnings than they were in the past", which is what I think people are usually saying.

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Re: Index funds is the reason for overvalued market

Post by qwertyjazz » Mon Dec 19, 2016 1:02 pm

The governance argument makes some sense to me. If the board of Vanguard, Blackrock or the Johnson family decided to re-write corporate America, they possibly could to a degree.

The index funds could I think increase valuations but not as cleanly as he suggests. Index funds make owning stock make sense to more people. More money will rationally go in the markets and prices could increase. Basically it is a better deal to avoid hedge funds which more people should realize
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TimeRunner
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Re: Index funds is the reason for overvalued market

Post by TimeRunner » Mon Dec 19, 2016 1:05 pm

I also remember reading opinions that said that gee, all the baby boomers retiring will be unwinding all their positions, and less people will be putting money into the market, yada yada. <rolleyes>
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Re: Index funds is the reason for overvalued market

Post by David Jay » Mon Dec 19, 2016 1:08 pm

Raymond wrote:
misterno wrote:...What do you think?
I think I hear the world's smallest violin playing :P

I guess an upgrade from his present Gulfstream G550 will have to be delayed.
dang...
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boglephreak
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Re: Index funds is the reason for overvalued market

Post by boglephreak » Mon Dec 19, 2016 1:20 pm

is it common in annual letters to attack the competition rather than explain why your own fund is doing so poorly?

lack_ey
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Re: Index funds is the reason for overvalued market

Post by lack_ey » Mon Dec 19, 2016 1:24 pm

RAchip wrote:If a greater and greater percent of the money entering the market does so via index funds, wont that create opportunities for individual stock pickers? If lots of money mobes in and out via indexes, thats a lot of buying and selling without reference to what is actually happening to individual companies.
Not necessarily if indexing (not much pricing pressure and none in relative terms within the index) is replacing uninformed active investing.

rbaldini wrote:Thanks. I guess it's hard for me to say whether something is overvalued when I haven't seen a precise definition of "overvalued" in the first place.

I suppose one can define an overvalued good as one that does not return "enough" utility per price. What would "not enough" mean? I suppose if it's intended to return wealth, "not enough" would mean either the return is less than the cost or, more generally, less than an alternative - because then a rational wealth maximizer wouldn't be buying it (well, unless it helps to diversify, etc - part of your utility function could be low volatility, etc). Applying this is hard because it would require us to know how much stock is going to return in the future, which of course we don't. If you believe the market is strictly a random walk with no predictive variables, then the expected return to stock is always the same, so it's impossible for it to be overvalued, right? (Except in hindsight, which is useless.)

In contrast, I don't think a good definition of "overvalued" is "prices are higher per earnings than they were in the past", which is what I think people are usually saying.
Agreed that "prices are higher per earnings than they were in the past" in of itself does not indicate over/under-valuation.

This is definitely not the only formulation people have in common usage, though. Especially when you look at analysts for individual securities, you frequently see a notion that X is worth Y but the actual price is Z, where Z > Y means overvalued. For example even Morningstar will give you a fair-value estimate (Y) for a given stock based on... something.

One way to value a stock is to estimate all future dividends (hopefully probabilistically but that is virtually impossible and I doubt it is that frequently done) or perhaps just earnings or some other flows and figure out the value of those things discounted back to the present day. Now, the discounting is not necessarily all that subjective as questions such as "how much is receiving $1 in 10 years worth today?" is answered pretty clearly by the bond market. Of course estimating the future behavior is hard, especially far in the future. And this is more or less a simpler form of knowing or guessing what the return is going to be.

In any case there are various structures and techniques for at least getting a sense of worth, rightly or wrongly, and some of these can be extended to the market as a whole.

Now, if it's a random walk in the way you described then sure, nothing is over/under-valued. That doesn't really fit the data, though, especially at the single-security level.

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Re: Index funds is the reason for overvalued market

Post by rbaldini » Mon Dec 19, 2016 1:34 pm

lack_ey wrote: Now, if it's a random walk in the way you described then sure, nothing is over/under-valued. That doesn't really fit the data, though, especially at the single-security level.
I see. Suppose it's the case that no one is reliably able to predict the stock market more accurately than a random walk model. Then it follows that no one could reliably say that the market as a whole is over or undervalued - even if the market isn't "actually" a random walk. Seems to me that we are sort of in this situation, right? Any claim to market-wide overvaluation must be pretty weak, I'd think.

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Re: Index funds is the reason for overvalued market

Post by lack_ey » Mon Dec 19, 2016 1:51 pm

rbaldini wrote:
lack_ey wrote: Now, if it's a random walk in the way you described then sure, nothing is over/under-valued. That doesn't really fit the data, though, especially at the single-security level.
I see. Suppose it's the case that no one is reliably able to predict the stock market more accurately than a random walk model. Then it follows that no one could reliably say that the market as a whole is over or undervalued - even if the market isn't "actually" a random walk. Seems to me that we are sort of in this situation, right? Any claim to market-wide overvaluation must be pretty weak, I'd think.
I would say yes, largely, though potentially allowing for exceptions, contingent on what precisely you mean by "reliably" and then what you are comparing the value to when assessing overvaluation.

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Re: Index funds is the reason for overvalued market

Post by abuss368 » Mon Dec 19, 2016 5:40 pm

misterno wrote:Says hedge fund manager Bill Ackma

http://www.pragcap.com/dear-hedge-funds ... r-returns/

What do you think?
Hi misterno,

Thank you for sharing. That is interesting. Index investors are buying a fund and thus accepting whatever returns the stock and bond markets are generous enough to provide. How can these investors overvalue a market?

While I am not certain, is the manager underperforming the market this year?
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Re: Index funds is the reason for overvalued market

Post by FillorKill » Mon Dec 19, 2016 5:43 pm

rbaldini wrote:Is the market overvalued?
Price is truth.

misterno
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Re: Index funds is the reason for overvalued market

Post by misterno » Mon Dec 19, 2016 6:05 pm

abuss368 wrote:
misterno wrote:Says hedge fund manager Bill Ackma

http://www.pragcap.com/dear-hedge-funds ... r-returns/

What do you think?
Hi misterno,

Thank you for sharing. That is interesting. Index investors are buying a fund and thus accepting whatever returns the stock and bond markets are generous enough to provide. How can these investors overvalue a market?

While I am not certain, is the manager underperforming the market this year?
We as the index fund buyers are lifting boats for the sp500 market not the all market.

Also the complaining fund manager's returns are less than sp500 which is no suprise

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Re: Index funds is the reason for overvalued market

Post by Call_Me_Op » Tue Dec 20, 2016 7:36 am

misterno wrote:Says hedge fund manager Bill Ackma

http://www.pragcap.com/dear-hedge-funds ... r-returns/

What do you think?
If yah can't beat 'em (index funds), criticize 'em.
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misterno
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Re: Index funds is the reason for overvalued market

Post by misterno » Wed Dec 28, 2016 4:31 pm

The more I think the more I am getting crazier

FED keeps printing money and does everything it can to keep pushing stock market up and up.

Everybody is happy because people's 401k values keeps rising and making investors happy

Wall street is happy because more trading higher index more volatility and they make more fees

Banks are happy their stock keeps going up

Politicians are happy because they can go to the stage and keep talking about rising retirement savings and promising false happiness

Man, this is crazy. This bubble will burst one day. If the switch to index funds keeps momentum like it has been in the last 10 years then P/E ratios will be out of whack I mean more out of whack

So what to do now?

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Re: Index funds is the reason for overvalued market

Post by triceratop » Wed Dec 28, 2016 4:46 pm

misterno wrote:The more I think the more I am getting crazier

FED keeps printing money and does everything it can to keep pushing stock market up and up.

Everybody is happy because people's 401k values keeps rising and making investors happy

Wall street is happy because more trading higher index more volatility and they make more fees

Indexing creates very little trading, and almost no money going to Wall Street. The Financial industry is as a whole despondent over Indexing's success; they are losing billions in high fees for questionable added value. That is why you see articles published with titles like "Indexing is worse than Marxism"

Banks are happy their stock keeps going up

Politicians are happy because they can go to the stage and keep talking about rising retirement savings and promising false happiness

Man, this is crazy. This bubble will burst one day. If the switch to index funds keeps momentum like it has been in the last 10 years then P/E ratios will be out of whack I mean more out of whack

So what to do now?

Indexing saw record inflows in 2015 and 2016, with Vanguard at the forefront.

Yet, there was a correction spanning those two years.

:confused
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