Passive investing is a Ponzi scheme

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gregchesney
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Passive investing is a Ponzi scheme

Post by gregchesney » Fri Aug 25, 2017 6:28 am

Wow, the chief investment officer of Ariel investments called passive investing a Ponzi scheme on Bloomberg!

https://www.bloomberg.com/news/videos/2 ... ting-video
Last edited by gregchesney on Fri Aug 25, 2017 8:59 am, edited 1 time in total.

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matjen
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Re: Active investing is a Ponzi scheme

Post by matjen » Fri Aug 25, 2017 6:36 am

That whole interview was little more than a word salad.
A man is rich in proportion to the number of things he can afford to let alone.

gregchesney
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Re: Active investing is a Ponzi scheme

Post by gregchesney » Fri Aug 25, 2017 6:46 am

matjen wrote:
Fri Aug 25, 2017 6:36 am
That whole interview was little more than a word salad.
I agree but I was astonished at the carelessness of her rhetoric.

jbolden1517
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Re: Active investing is a Ponzi scheme

Post by jbolden1517 » Fri Aug 25, 2017 8:10 am

gregchesney wrote:
Fri Aug 25, 2017 6:46 am
matjen wrote:
Fri Aug 25, 2017 6:36 am
That whole interview was little more than a word salad.
I agree but I was astonished at the carelessness of her rhetoric.
Why? She runs a value house and manages some value funds. She has a lot of funds that trade in illiquid parts of stock markets. She sees wide spreads everyday when stocks have fallen hard. She believes in buying stocks based on their fundamentals. Indexers believe in buying stocks based on their floats deliberately ignoring all fundamentals. Why wouldn't you expect her to see your approach as reckless and destructive?

We now have hundreds if not thousands of market professionals coming forward and saying float trading is breaking the ability of the stock market to accurately price assets either in relative or absolute terms. We have hundreds of market professionals coming forward and saying that float trading has completely distorted the bond market and it isn't merely breaking it is broken (btw Bogle himself is one of these with regard to the Barclay's index which is the one used by Vanguard). We have dozens of market professionals coming forward and talking about how passive investing is shifting internal corporate finance in ways that are potentially highly destructive to long term equity returns both in terms of corporate leverage and dilution financing.

The assumption on Bogleheads is all of these people are lying. The belief is that Indexing is somehow a unique trading strategy and unlike the countless other examples of trading strategies that got popular and caused distortion. It is assumed that nothing like that could ever possibly happen and certainly not at a mere 95% of net inflows some months. When one points to examples in particular stocks where it obviously is happening it is ignored because of course it is impossible so why look at evidence? In the interview she did mention specific examples of where she felt the risk in indexing were particularly acute with the FANG stocks vs. stocks like Microsoft where you get the same growth at more reasonable valuations. Pretty standard GARP ideology, doing relative industry and sector valuation. The sort of thing that indexers often claim to support when they argue they aren't buying random stocks at random prices. She's not saying anything unusual at all.

I'm not sure what's reckless about her rhetoric. Now of course if you assume she's just another one of those liars trying to scare people then sure you can consider her reckless. But if you don't she makes a pretty good point about valuations? And moreover why is it is completely illegitimate for people to disagree with you about stuff? Even if they are wrong are you so sure they are just lying?

I think her point about spreads is unlikely. That being said, in 2007 if you had asked me about the spreads we saw in the overall bond market I would have considered those sorts of spreads to be next to impossible as well. And yet a year later I got my [head --admin LadyGeek] handed to me, learning it was possible. I didn't live through the depression but in 1931-1932 you saw huge spreads for even for Dow stocks.

(BTW for lurkers she said passive is like a ponzi scheme not active. OP had it backwards. By passive I think she meant cap weighted though it wasn't clarified in the interview if she saw this as applying more broadly).

TheHouse7
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Re: Active investing is a Ponzi scheme

Post by TheHouse7 » Fri Aug 25, 2017 8:26 am

jbolden1517 wrote:
Fri Aug 25, 2017 8:10 am
gregchesney wrote:
Fri Aug 25, 2017 6:46 am
matjen wrote:
Fri Aug 25, 2017 6:36 am
That whole interview was little more than a word salad.
I agree but I was astonished at the carelessness of her rhetoric.
Why? She runs a value house and manages some value funds. She has a lot of funds that trade in illiquid parts of stock markets. She sees wide spreads everyday when stocks have fallen hard. She believes in buying stocks based on their fundamentals. Indexers believe in buying stocks based on their floats deliberately ignoring all fundamentals. Why wouldn't you expect her to see your approach as reckless and destructive?

We now have hundreds if not thousands of market professionals coming forward and saying float trading is breaking the ability of the stock market to accurately price assets either in relative or absolute terms. We have hundreds of market professionals coming forward and saying that float trading has completely distorted the bond market and it isn't merely breaking it is broken (btw Bogle himself is one of these with regard to the Barclay's index which is the one used by Vanguard). We have dozens of market professionals coming forward and talking about how passive investing is shifting internal corporate finance in ways that are potentially highly destructive to long term equity returns both in terms of corporate leverage and dilution financing.

The assumption on Bogleheads is all of these people are lying. The belief is that Indexing is somehow a unique trading strategy and unlike the countless other examples of trading strategies that got popular and caused distortion. It is assumed that nothing like that could ever possibly happen and certainly not at a mere 95% of net inflows some months. When one points to examples in particular stocks where it obviously is happening it is ignored because of course it is impossible so why look at evidence? In the interview she did mention specific examples of where she felt the risk in indexing were particularly acute with the FANG stocks vs. stocks like Microsoft where you get the same growth at more reasonable valuations. Pretty standard GARP ideology, doing relative industry and sector valuation. The sort of thing that indexers often claim to support when they argue they aren't buying random stocks at random prices. She's not saying anything unusual at all.

I'm not sure what's reckless about her rhetoric. Now of course if you assume she's just another one of those liars trying to scare people then sure you can consider her reckless. But if you don't she makes a pretty good point about valuations? And moreover why is it is completely illegitimate for people to disagree with you about stuff? Even if they are wrong are you so sure they are just lying?

I think her point about spreads is unlikely. That being said, in 2007 if you had asked me about the spreads we saw in the overall bond market I would have considered those sorts of spreads to be next to impossible as well. And yet a year later I got my ass handed to me, learning it was possible. I didn't live through the depression but in 1931-1932 you saw huge spreads for even for Dow stocks.

(BTW for lurkers she said passive is like a ponzi scheme not active. OP had it backwards. By passive I think she meant cap weighted though it wasn't clarified in the interview if she saw this as applying more broadly).
+1 Thanks for the lurkers comment, made me feel like I was part of the conversation.
"PSX will always go up 20%, why invest in anything else?!" -Father-in-law early retired.

Tamalak
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Re: Active investing is a Ponzi scheme

Post by Tamalak » Fri Aug 25, 2017 8:29 am

Active investing (with high fees) is a simple scam, not a Ponzi scheme. It doesn't have anything like the structure of a Ponzi scheme.

Da5id
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Re: Active investing is a Ponzi scheme

Post by Da5id » Fri Aug 25, 2017 8:30 am

jbolden1517 wrote:
Fri Aug 25, 2017 8:10 am
We now have hundreds if not thousands of market professionals coming forward and saying float trading is breaking the ability of the stock market to accurately price assets either in relative or absolute terms. We have hundreds of market professionals coming forward and saying that float trading has completely distorted the bond market and it isn't merely breaking it is broken (btw Bogle himself is one of these with regard to the Barclay's index which is the one used by Vanguard). We have dozens of market professionals coming forward and talking about how passive investing is shifting internal corporate finance in ways that are potentially highly destructive to long term equity returns both in terms of corporate leverage and dilution financing.
I'll believe it more when it comes from academics rather than interested parties. I'll particularly consider acting on it when SPIVA shows these inaccuracies in pricing are being exploited by an increasing number of active money managers who can see and (in a cost effective way) take advantage of these supposedly obvious pricing distortions. Heck, why would a skilled professional active stock or bond fund manager feel a need to complain about market pricing distortions or anomalies from indexing? I'd think they'd welcome them as their superior knowledge would let them exploit the "dumb money" index investors rather than continue the series of embarrassing defeats the vast majority of active managers have experienced compared to their target indexes?

That doesn't change your last point, which I don't know enough about. But I also don't think it is amenable to attack, as indexing is here to stay.

jdilla1107
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Re: Active investing is a Ponzi scheme

Post by jdilla1107 » Fri Aug 25, 2017 8:37 am

jbolden1517 wrote:
Fri Aug 25, 2017 8:10 am

In the interview she did mention specific examples of where she felt the risk in indexing were particularly acute with the FANG stocks vs. stocks like Microsoft where you get the same growth at more reasonable valuations.
Why doesn't she invest in FANG stocks, stay away from Microsoft, and enjoy her outsized returns? Active managers should be overjoyed about the "problems with indexing" as it should be creating the distortions they could take advantage of.

Not trolling, I honestly don't get it. If I truly believed that FANG stocks produced higher returns than Microsoft for the same risk, that seems like a free lunch. What is there to complain about with extra return for the same risk? She's worried about retirees stuck in MS stock? Please.

McGilicutty
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Re: Active investing is a Ponzi scheme

Post by McGilicutty » Fri Aug 25, 2017 9:00 am

95% of inflows are going to passive investments in some months? Wow! No wonder these active money managers are warning that the sky is falling. The sky is definitely falling, but it is going to land directly on active money managers' high fees.

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TD2626
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Re: Active investing is a Ponzi scheme

Post by TD2626 » Fri Aug 25, 2017 9:01 am

jbolden1517 wrote:
Fri Aug 25, 2017 8:10 am
The belief is that Indexing is somehow a unique trading strategy and unlike the countless other examples of trading strategies that got popular and caused distortion.
Indexing is a unique strategy in that it has very large capacity - a large portion of the market can index, long-term, without causing any issues. It also has strong theoretical backing (via the efficient market hypothesis). Other strategies (like, say, value tilting or momentum investing) would cause distortion at far lower levels of adoption. People will continue to actively invest, though. I think that with the costs of active coming down (Vanguard's Wellington admiral ER is at 0.16%) the benefits of passive are reduced - but not eliminated. Active management adds risk in two ways - risk of both underperformance and overpeformance of the index.

james22
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Re: Active investing is a Ponzi scheme

Post by james22 » Fri Aug 25, 2017 9:03 am

jbolden1517 wrote:
Fri Aug 25, 2017 8:10 am
gregchesney wrote:
Fri Aug 25, 2017 6:46 am
matjen wrote:
Fri Aug 25, 2017 6:36 am
That whole interview was little more than a word salad.
I agree but I was astonished at the carelessness of her rhetoric.
Why? She runs a value house and manages some value funds. She has a lot of funds that trade in illiquid parts of stock markets. She sees wide spreads everyday when stocks have fallen hard. She believes in buying stocks based on their fundamentals. Indexers believe in buying stocks based on their floats deliberately ignoring all fundamentals. Why wouldn't you expect her to see your approach as reckless and destructive?

We now have hundreds if not thousands of market professionals coming forward and saying float trading is breaking the ability of the stock market to accurately price assets either in relative or absolute terms. We have hundreds of market professionals coming forward and saying that float trading has completely distorted the bond market and it isn't merely breaking it is broken (btw Bogle himself is one of these with regard to the Barclay's index which is the one used by Vanguard). We have dozens of market professionals coming forward and talking about how passive investing is shifting internal corporate finance in ways that are potentially highly destructive to long term equity returns both in terms of corporate leverage and dilution financing.

The assumption on Bogleheads is all of these people are lying. The belief is that Indexing is somehow a unique trading strategy and unlike the countless other examples of trading strategies that got popular and caused distortion. It is assumed that nothing like that could ever possibly happen and certainly not at a mere 95% of net inflows some months. When one points to examples in particular stocks where it obviously is happening it is ignored because of course it is impossible so why look at evidence? In the interview she did mention specific examples of where she felt the risk in indexing were particularly acute with the FANG stocks vs. stocks like Microsoft where you get the same growth at more reasonable valuations. Pretty standard GARP ideology, doing relative industry and sector valuation. The sort of thing that indexers often claim to support when they argue they aren't buying random stocks at random prices. She's not saying anything unusual at all.

I'm not sure what's reckless about her rhetoric. Now of course if you assume she's just another one of those liars trying to scare people then sure you can consider her reckless. But if you don't she makes a pretty good point about valuations? And moreover why is it is completely illegitimate for people to disagree with you about stuff? Even if they are wrong are you so sure they are just lying?
:beer
This whole episode is likely to end so badly that future children will learn about it in school and shake their heads in wonder at the rank stupidity of it all... Hussman

jbolden1517
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Re: Active investing is a Ponzi scheme

Post by jbolden1517 » Fri Aug 25, 2017 9:09 am

Da5id wrote:
Fri Aug 25, 2017 8:30 am
jbolden1517 wrote:
Fri Aug 25, 2017 8:10 am
We now have hundreds if not thousands of market professionals coming forward and saying float trading is breaking the ability of the stock market to accurately price assets either in relative or absolute terms. We have hundreds of market professionals coming forward and saying that float trading has completely distorted the bond market and it isn't merely breaking it is broken (btw Bogle himself is one of these with regard to the Barclay's index which is the one used by Vanguard). We have dozens of market professionals coming forward and talking about how passive investing is shifting internal corporate finance in ways that are potentially highly destructive to long term equity returns both in terms of corporate leverage and dilution financing.
I'll believe it more when it comes from academics rather than interested parties.
So will I. But in general when that happens we'll also have lots of historical foresight and it won't matter nearly as much as it will be about something that did happen not something that is happening. Academics do good work, but they don't do it quickly.
Da5id wrote:
Fri Aug 25, 2017 8:30 am
I'll particularly consider acting on it when SPIVA shows these inaccuracies in pricing are being exploited by an increasing number of active money managers who can see and (in a cost effective way) take advantage of these supposedly obvious pricing distortions.
I wouldn't go off one year's results but it is happening this year. That being said I agree that like in most bubbles when you see the damage is during the selling not during the buying. The money is lost in the bull, the losses are realized during the bear. Grabbing my crystal ball for a moment I'm going to agree with BofA's analysis. I don't think active outperforms even during the time of outflows. What would outperform are passive funds using simple quantitative measures (value etfs). Once the market is dominated by passive etfs, that is after the outflows are well underway then predicting 6-18 mo earnings becomes an extremely valuable type of research. The returns generated from the research will far exceed the cost of performing the research. That's when I'd expect to see active outperform passive. About 1/2 way though that process cap weighted indexing incidentally would work quite well. Arbitraging away the cost of the research gets increasingly valuable as the research cost goes up.

I applaud the fact you came up with a test. The problem with your metric is that it will trail by many years what you want to measure. Its like trying to determine if you are too close to the car in front of you by checking whether your hood is still intact.
Da5id wrote:
Fri Aug 25, 2017 8:30 am
Heck, why would a skilled professional active stock or bond fund manager feel a need to complain about market pricing distortions or anomalies from indexing? I'd think they'd welcome them as their superior knowledge would let them exploit the "dumb money" index investors rather than continue the series of embarrassing defeats the vast majority of active managers have experienced compared to their target indexes?
Stock and bond managers get paid on assets under management not returns. Strategies which produce superior returns but don't appeal to investors are from their perspective not utilizable. The classic example is: growth outperforms value in most 3 year periods, value outperforms growth in almost all 20 year periods. That's because mutual fund managers and pension fund managers tilt growth since it enhances their profits.
Da5id wrote:
Fri Aug 25, 2017 8:30 am
That doesn't change your last point, which I don't know enough about. But I also don't think it is amenable to attack, as indexing is here to stay.
No doubt cap weighting as a form of investing is here to stay. I do however think 10 years from now cap weighting will just be one among many indexing schemes on par with: earnings weighting, sales weighting, dividends weighting, cash flow weighting.... It will have a reputation as being dangerous but the cheapest to administer. Cost matter. But right now there is a conflation between SP500 cap weighted index funds, all cap weighted funds, indexing in general and passive in general. I don't think people are picking apart which of the advantages of SP500 indexes are true of those broader categories. As an aside this isn't just the pro side, the anti side is perhaps worse I've seen attacks on indexing that would apply to almost all mutual funds companies, pension fund companies and institutional wealth managers.

QQQ as a future and as an index was very big when I started on par with SPX among retail investors. When average people talked about "indexing" they often meant QQQ not TSM or SPX. So I've personally witnessed indexes go out of fashion with retail investors.

Da5id
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Re: Active investing is a Ponzi scheme

Post by Da5id » Fri Aug 25, 2017 9:22 am

jbolden1517 wrote:
Fri Aug 25, 2017 9:09 am
Da5id wrote:
Fri Aug 25, 2017 8:30 am
Heck, why would a skilled professional active stock or bond fund manager feel a need to complain about market pricing distortions or anomalies from indexing? I'd think they'd welcome them as their superior knowledge would let them exploit the "dumb money" index investors rather than continue the series of embarrassing defeats the vast majority of active managers have experienced compared to their target indexes?
Stock and bond managers get paid on assets under management not returns. Strategies which produce superior returns but don't appeal to investors are from their perspective not utilizable. The classic example is: growth outperforms value in most 3 year periods, value outperforms growth in almost all 20 year periods. That's because mutual fund managers and pension fund managers tilt growth since it enhances their profits.
Even in this increasingly indexed world, people chase returns. Some going to indexing or who are doing various tilts are no doubt chasing returns rather than choosing a new long term strategy based on its theoretical underpinnings. If active funds put together a string of victories the money will indeed flow there. So those managers who are in my opinion largely "concern trolling" need not worry. If they can consistently beat their target indexes, the money will undoubtedly flow to them.

And if SPIVA is a trailing indicator, so be it. I'm not a believer in the evils of indexing, and am not a newcomer to the strategy. I've been indexing since the 80s (way back when Vanguard Extended Market had a sales charge payable to the fund) after learning the folly of chasing yesterday's five star rated winners -- Japan Fund and Magellan in my case. Other than 401ks that didn't have indexes, I've only invested in index funds since the 80s. I believe very strongly that sticking to an investing strategy is important, and one should be very slow to change one's plans in the face of the constant noise that exists in the investing world. And I think this FUD about indexing is, to me, at this point part of the noise.
Last edited by Da5id on Fri Aug 25, 2017 9:23 am, edited 1 time in total.

jbolden1517
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Re: Active investing is a Ponzi scheme

Post by jbolden1517 » Fri Aug 25, 2017 9:22 am

jdilla1107 wrote:
Fri Aug 25, 2017 8:37 am
jbolden1517 wrote:
Fri Aug 25, 2017 8:10 am

In the interview she did mention specific examples of where she felt the risk in indexing were particularly acute with the FANG stocks vs. stocks like Microsoft where you get the same growth at more reasonable valuations.
Why doesn't she invest in FANG stocks, stay away from Microsoft, and enjoy her outsized returns? Active managers should be overjoyed about the "problems with indexing" as it should be creating the distortions they could take advantage of.

Not trolling, I honestly don't get it. If I truly believed that FANG stocks produced higher returns than Microsoft for the same risk, that seems like a free lunch. What is there to complain about with extra return for the same risk? She's worried about retirees stuck in MS stock? Please.
You have that backwards. She's saying the ratio of intrinsic value to market price for Microsoft is much higher than for Facebook. So over say a 30 year time horizon Microsoft will produce with very high probability much better return. On the other hand over a one year time frame the price increase (plus any dividends) of Facebook (of Amazon or Google) is likely to exceed the price increase plus dividend of Microsoft. You will on average get better one year return from Facebook than Microsoft. The problem with making this play is you are taking on tremendous market risk by holding Facebook. Most of the share price is the cost of playing the ponzi scheme not the intrinsic value of the stock.

Indexes cap weight. The larger the ponzi scheme component of a shareprice the bigger the bet they make on that scheme working out next year. And they never rebalance out of the scheme (though investors in indexes might rebalance into other funds). Cap weighted indexes increased their share of technology from 14% to 31% during the 90s tech runup.

jdilla1107
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Re: Active investing is a Ponzi scheme

Post by jdilla1107 » Fri Aug 25, 2017 9:35 am

jbolden1517 wrote:
Fri Aug 25, 2017 9:22 am
The problem with making this play is you are taking on tremendous market risk by holding Facebook. Most of the share price is the cost of playing the ponzi scheme not the intrinsic value of the stock.
This is precisely the point. Risk is a component of price, right? To get more return you have to take on more risk.

If enough people chose to not hold MS the problem would take care of itself. If MS is the problem then all active managers have to do is hold the companies which will generate outsized returns.

Tallis
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Re: Active investing is a Ponzi scheme

Post by Tallis » Fri Aug 25, 2017 9:36 am

Da5id wrote:
Fri Aug 25, 2017 8:30 am
Heck, why would a skilled professional active stock or bond fund manager feel a need to complain about market pricing distortions or anomalies from indexing? I'd think they'd welcome them as their superior knowledge would let them exploit the "dumb money" index investors rather than continue the series of embarrassing defeats the vast majority of active managers have experienced compared to their target indexes?
Quoted for truth. I'll believe that passive investing strategies are distorting the market when I see active funds taking advantage of the distortions to consistently make more money than the market average. Until then I'll take this interview as more concern trolling from a salesperson.
Last edited by Tallis on Fri Aug 25, 2017 9:42 am, edited 1 time in total.

jbolden1517
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Re: Active investing is a Ponzi scheme

Post by jbolden1517 » Fri Aug 25, 2017 9:39 am

Da5id wrote:
Fri Aug 25, 2017 9:22 am
jbolden1517 wrote:
Fri Aug 25, 2017 9:09 am
Da5id wrote:
Fri Aug 25, 2017 8:30 am
Heck, why would a skilled professional active stock or bond fund manager feel a need to complain about market pricing distortions or anomalies from indexing? I'd think they'd welcome them as their superior knowledge would let them exploit the "dumb money" index investors rather than continue the series of embarrassing defeats the vast majority of active managers have experienced compared to their target indexes?
Stock and bond managers get paid on assets under management not returns. Strategies which produce superior returns but don't appeal to investors are from their perspective not utilizable. The classic example is: growth outperforms value in most 3 year periods, value outperforms growth in almost all 20 year periods. That's because mutual fund managers and pension fund managers tilt growth since it enhances their profits.
Even in this increasingly indexed world, people chase returns.
But they chase 3 year return not 20 year return. That's the key point.
Da5id wrote:
Fri Aug 25, 2017 9:22 am
Some going to indexing or who are doing various tilts are no doubt chasing returns rather than choosing a new long term strategy based on its theoretical underpinnings. If active funds put together a string of victories the money will indeed flow there. So those managers who are in my opinion largely "concern trolling" need not worry. If they can consistently beat their target indexes, the money will undoubtedly flow to them.
That can't happen unless there is some reason that the holdings of index funds and the holding of active managers are wildly distinct. Indexers are wrong that active investors can't in the aggregate beat the returns of themselves.

For example if a very large percentage of the market is controlled by a group of investors disinterested in return. This is what happened in Japan to VPACX where the active managers did beat the index consistently for an extended period of time. Or what's in bonds now, most notably in European bonds.

Or alternatively if the trading frequency is high then the return of the index fund and the return of the index can diverge. The index can bleed from poor trade execution strategies. Which is what has happened with many of the Russell 2000 index funds including Vanguards. Another possibility that's similar to this is if control investors engaged in extensive float manipulation. Index funds, being float traders, would bleed assets very quickly to this sort of counter indexing-strategy. Actively managed funds could remain relatively indifferent to float manipulation or possibly benefit from taking the opposite side of the index funds. When it started you wouldn't see in terms of "total return" since the loses from the index funds would take the form of rapidly buying overpriced stocks which until the price declines looks like return.
If you were to use some objective measure like "share of total earnings" or "share of total book" it would be noticeable. Otherwise potentially this damage goes on for years. The index funds would track the index, the indexes returns would start off amazing and then become increasingly poor.
Da5id wrote:
Fri Aug 25, 2017 9:22 am
And if SPIVA is a trailing indicator, so be it. I'm not a believer in the evils of indexing, and am not a newcomer to the strategy. I've been indexing since the 80s (way back when Vanguard Extended Market had a sales charge payable to the fund) after learning the folly of chasing yesterday's five star rated winners -- Japan Fund and Magellan in my case. I believe very strongly that sticking to an investing strategy is important, and one should be very slow to change one's plans in the face of the constant noise that exists in the investing world. And I think this FUD about indexing is, to me, at this point part of the noise.
Are you sure you don't mean the 1990s? The sales charge definitely existed then (I paid it for the EM and Asia fund, plus one other I don't recall right now). Japan fund and Magellan were rather spectacular in the 1980s not sure how you would have learned your lessen holding those :)

zenon
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Re: Active investing is a Ponzi scheme

Post by zenon » Fri Aug 25, 2017 9:48 am

McGilicutty wrote:
Fri Aug 25, 2017 9:00 am
95% of inflows are going to passive investments in some months? Wow! No wonder these active money managers are warning that the sky is falling. The sky is definitely falling, but it is going to land directly on active money managers' high fees.
These inflows are highly distorted, I wouldn't use them. That's because many active investors use ETFs in their portfolios and even retail investors may not hold the investment for that long. One shouldn't assume that just because money entered a nominally passive ETF that therefore it's a passive investment.

And secondly, those who are actually passively investing, I can imagine that this can lift the stock market but one benefit is that at least it doesn't disturb the relative valuations (assuming you're investing in the total market).

zenon
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Re: Active investing is a Ponzi scheme

Post by zenon » Fri Aug 25, 2017 9:50 am

Tallis wrote:
Fri Aug 25, 2017 9:36 am
Da5id wrote:
Fri Aug 25, 2017 8:30 am
Heck, why would a skilled professional active stock or bond fund manager feel a need to complain about market pricing distortions or anomalies from indexing? I'd think they'd welcome them as their superior knowledge would let them exploit the "dumb money" index investors rather than continue the series of embarrassing defeats the vast majority of active managers have experienced compared to their target indexes?
Quoted for truth. I'll believe that passive investing strategies are distorting the market when I see active funds taking advantage of the distortions to consistently make more money than the market average. Until then I'll take this interview as more concern trolling from a salesperson.
They are doing that already. For example buying up stocks that are more likely to enter an index and shorting the stocks getting out. This kind of opportunities are not created by total market funds though.

JFP_SF
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Re: Active investing is a Ponzi scheme

Post by JFP_SF » Fri Aug 25, 2017 9:51 am

jdilla1107 wrote:
Fri Aug 25, 2017 8:37 am
jbolden1517 wrote:
Fri Aug 25, 2017 8:10 am

In the interview she did mention specific examples of where she felt the risk in indexing were particularly acute with the FANG stocks vs. stocks like Microsoft where you get the same growth at more reasonable valuations.
Why doesn't she invest in FANG stocks, stay away from Microsoft, and enjoy her outsized returns? Active managers should be overjoyed about the "problems with indexing" as it should be creating the distortions they could take advantage of.

Not trolling, I honestly don't get it. If I truly believed that FANG stocks produced higher returns than Microsoft for the same risk, that seems like a free lunch. What is there to complain about with extra return for the same risk? She's worried about retirees stuck in MS stock? Please.
You have that backwards. She is saying Microsoft is a better investment than the FANG stocks.

jbolden1517
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Re: Active investing is a Ponzi scheme

Post by jbolden1517 » Fri Aug 25, 2017 9:55 am

jdilla1107 wrote:
Fri Aug 25, 2017 9:35 am
The problem with making this play is you are taking on tremendous market risk by holding Facebook. Most of the share price is the cost of playing the ponzi scheme not the intrinsic value of the stock.
This is precisely the point. Risk is a component of price, right? To get more return you have to take on more risk. [/quote]

That's what EMHers believe. You are subtly assuming the point in question regarding indexing. The woman from Ariel investments (Rupal Bhansali) is a value investor. She believes you can enhance return and reduce risk by doing a few simple things to check whether a stock is reasonably priced or not. As a result you don't buy into momentum driven ponzi schemes at all. A momentum driven ponzi scheme has a high average return most years, the serial return, the long term return is negative.

Say for example I let you roll dice.
If either die hits a 1 you drop 80% (this happens 30.5% of the time).
If you rolled anything other than doubles I'd pay +50% (this happens 69.5% of the time)
Most years you get 50%. That's your mode. The arithmetic return of that investment is still pretty good, over 10%. The serial return however is -23.4%. In other words it may make sense to hold an asset this volatile but only if you are rebalancing out of it regularly. If you don't you hemorrhage money. An index fund doesn't rebalance out.
jdilla1107 wrote:
Fri Aug 25, 2017 9:35 am
If enough people chose to not hold MS the problem would take care of itself. If MS is the problem then all active managers have to do is hold the companies which will generate outsized returns.
Which would be easy if they didn't have to contend with investors who behave as if they were mostly disinterested in the long term return of their assets and highly interested in the shorter term returns.

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Re: Passive investing is a Ponzi scheme

Post by deltaneutral83 » Fri Aug 25, 2017 10:00 am

If indexing causes distortion in prices, this is something active managers who claim to be brilliant would love, no? Most of vanguard people have said we should be ok for price discovery well into the 70s for % of passive investing. I think we're still shy of 40% today with a lot of big moves made just to get to this point. I noticed she didn't mention her 25 year track record against respective benchmarks.

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Re: Passive investing is a Ponzi scheme

Post by Wakefield1 » Fri Aug 25, 2017 10:03 am

Was there a time when most stocks were held by individual investors,not institutions and mutual funds?
In such a time did active management work best since it was the presumably sophisticated fund manager vs. less sophisticated individual stock holders? (Playing the zero sum trading games or buying and holding)
In the modern era I understand more stocks are owned by institutions and mutual funds than are owned by individuals.
Bogle seems to think that in the past mutual funds tended to do less trading than in the modern era,and I think he was talking about actively managed (stock holding) mutual funds. "stock swapping"

to the people who fear that the large cap index has vastly overvalued and thus overweighted stocks,would using indexes such as the "midcap" or '"small cap value fund" reduce this disadvantage? (I confess that the last time I was about to send a check to "Index 500" I instead sent it to "Mid-Cap")

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Re: Passive investing is a Ponzi scheme

Post by staythecourse » Fri Aug 25, 2017 10:11 am

deltaneutral83 wrote:
Fri Aug 25, 2017 10:00 am
If indexing causes distortion in prices, this is something active managers who claim to be brilliant would love, no?
Can some folks add to this question?

I have thought the same. If there is more distortion in the market as to what the "accurate" "value" is of the stock shouldn't active managers like that? That means they should have MORE belief that they can generate alpha? That does not seem to be true as it seems everyday a new manager is coming out and throwing a new volley at passive investing.

BTW, can anyone link a return message by Mr. Bogle in response to these new attacks?

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

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Re: Passive investing is a Ponzi scheme

Post by CantPassAgain » Fri Aug 25, 2017 10:16 am

staythecourse wrote:
Fri Aug 25, 2017 10:11 am
BTW, can anyone link a return message by Mr. Bogle in response to these new attacks?

Good luck.
I'm more interested as to what is going on behind the scenes that has caused this incredible onslaught at Bogleheads.org over the last month or so. Very curious.

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Re: Passive investing is a Ponzi scheme

Post by jbolden1517 » Fri Aug 25, 2017 10:32 am

staythecourse wrote:
Fri Aug 25, 2017 10:11 am

I have thought the same. If there is more distortion in the market as to what the "accurate" "value" is of the stock shouldn't active managers like that? That means they should have MORE belief that they can generate alpha? That does not seem to be true as it seems everyday a new manager is coming out and throwing a new volley at passive investing.
Contrary to the opinion on Bogleheads they aren't saying they can't generate alpha. That's what people here claim the the analysts and managers are saying completely disregarding their actual comments. What they are saying is that mass indexing is greatly increasing systematic risks to the market. The reason people hold mutual funds is to control their investment risk. The managers and analysts are advising their clients they can only avoid systematic risk at the expensive of moving towards lower volatility stocks which mean their annual returns will be lower while inflows to index funds continue even though this type of strategy will boost longer term return (i.e. they are generating alpha years from now but it won't be apparent in total return). Value managers who are less concerned with market risk aren't complaining about a lack of alpha, they are finding plenty, but rather a low levels of long term beta.

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Re: Passive investing is a Ponzi scheme

Post by dwickenh » Fri Aug 25, 2017 10:37 am

I think the obvious point that is overlooked in this discussion is the future. It is unknown to the scholars and simpletons alike. Being intelligent does not shape the future, it often comforts us to think we know what is coming. If an active value strategy is your view of where future returns excel, go for it. If you feel you are better served by a simple index strategy, spend time with the kids and stay the course. Neither will be wrong if both reach their goals.
The market is the most efficient mechanism anywhere in the world for transferring wealth from impatient people to patient people.” | — Warren Buffett

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Re: Active investing is a Ponzi scheme

Post by nedsaid » Fri Aug 25, 2017 10:47 am

jbolden1517 wrote:
Fri Aug 25, 2017 8:10 am
gregchesney wrote:
Fri Aug 25, 2017 6:46 am
matjen wrote:
Fri Aug 25, 2017 6:36 am
That whole interview was little more than a word salad.
I agree but I was astonished at the carelessness of her rhetoric.
Why? She runs a value house and manages some value funds. She has a lot of funds that trade in illiquid parts of stock markets. She sees wide spreads everyday when stocks have fallen hard. She believes in buying stocks based on their fundamentals. Indexers believe in buying stocks based on their floats deliberately ignoring all fundamentals. Why wouldn't you expect her to see your approach as reckless and destructive?

Nedsaid: For one thing, active management is not dead. My guess is that active management will lose a lot of market share but at some point that will stabilize. Even if active management went away, which it won't, you still have all the factor funds out there. Pretty much, the academics are like the cavalry coming in to rescue market efficiency and the factor funds like DFA will make certain market inefficiencies are captured. Also you have the professional traders, arbitrageurs, shareholder activists, hedge funds, flash traders, the leverage buy-out people out there and they aren't going away. There will always be people out there who will make the markets efficient. And don't forget the robots.

We now have hundreds if not thousands of market professionals coming forward and saying float trading is breaking the ability of the stock market to accurately price assets either in relative or absolute terms. We have hundreds of market professionals coming forward and saying that float trading has completely distorted the bond market and it isn't merely breaking it is broken (btw Bogle himself is one of these with regard to the Barclay's index which is the one used by Vanguard). We have dozens of market professionals coming forward and talking about how passive investing is shifting internal corporate finance in ways that are potentially highly destructive to long term equity returns both in terms of corporate leverage and dilution financing.

Nedsaid: I think there is a point here but it is overstated. The lady mentioned lack of liquidity in markets when everyone wants to sell, but that would be even more of a problem for an active manager who is holding stocks that are less liquid. Pretty much, when everybody hits the exits at the same time, price has to drop enough to where buyers are willing to come in and buy albeit at a greatly reduced price. This has always been a problem in the markets, not sure indexing has contributed to it.

There is the argument that indexing distorts the markets, buying stocks regardless of valuations. My guess is that if this was happening that the Value premium, or at least the future expected returns of Value stocks, would greatly increase. I see no evidence this is happening. Indeed, the robots crank away 24/7 looking for market inefficiencies. The overwhelming evidence is that markets are becoming more efficient not less so, hence the shrinking alpha.


The assumption on Bogleheads is all of these people are lying. The belief is that Indexing is somehow a unique trading strategy and unlike the countless other examples of trading strategies that got popular and caused distortion. It is assumed that nothing like that could ever possibly happen and certainly not at a mere 95% of net inflows some months. When one points to examples in particular stocks where it obviously is happening it is ignored because of course it is impossible so why look at evidence? In the interview she did mention specific examples of where she felt the risk in indexing were particularly acute with the FANG stocks vs. stocks like Microsoft where you get the same growth at more reasonable valuations. Pretty standard GARP ideology, doing relative industry and sector valuation. The sort of thing that indexers often claim to support when they argue they aren't buying random stocks at random prices. She's not saying anything unusual at all.

Nedsaid: I suppose it is what I call the race to the bottom. I do think there is more to investing than just low costs. Sort of why I buy groceries at Kroger rather than Wal-Mart. I want to see the help get living wages. We could drive costs down to the point where customer service becomes very, very spotty. A lot of threads here expressing concerns about Vanguard's customer service. There gets to be a point where there is too much of a good thing.

If markets started getting inefficient, I suppose the standard advice around here would no longer be to invest 100% passive but perhaps 70% passive indexes and 30% factor funds or low cost active management. It would sort of be like a sacrifice to the trading Gods, buy enough active management to keep the rest of the market efficient. Paying dues to the efficient markets club.

So far, the evidence is that indexing has not distorted the markets. I think Mr. Bogle believes that your need only 20% active to keep the rest of the market efficient. I just have a hard time believing that indexing in itself is setting market prices. Another thing is that the good indexers are also really good traders and we are seeing the use of patient trading strategies to alleviate the problem of indexing itself affecting prices either on the upside or the downside. One example is that they are aware of the traders front-running the indexes and the indexers have taken steps to reduce the drag from front running.


I'm not sure what's reckless about her rhetoric. Now of course if you assume she's just another one of those liars trying to scare people then sure you can consider her reckless. But if you don't she makes a pretty good point about valuations? And moreover why is it is completely illegitimate for people to disagree with you about stuff? Even if they are wrong are you so sure they are just lying?

Nedsaid: I don't think they are lying, I am sure they see in limited fashion how the indexers might be distorting the markets stock by stock. But when you look at the entire market, I don't see evidence for it yet. Believe me, there are legions of folks out there plus the robots who are looking 24/7 for market inefficiencies.


I think her point about spreads is unlikely. That being said, in 2007 if you had asked me about the spreads we saw in the overall bond market I would have considered those sorts of spreads to be next to impossible as well. And yet a year later I got my ass handed to me, learning it was possible. I didn't live through the depression but in 1931-1932 you saw huge spreads for even for Dow stocks.

Nedsaid: But in market panics, this has always been a problem. Don't think indexing by itself would cause this problem. So far, I see no evidence that indexers will run out of people to sell to. At some point there could be a point where too much passive money would increase the risk of a run on the stock market and a lack of buyers, but I think it is a long ways off.

(BTW for lurkers she said passive is like a ponzi scheme not active. OP had it backwards. By passive I think she meant cap weighted though it wasn't clarified in the interview if she saw this as applying more broadly).
A fool and his money are good for business.

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Re: Passive investing is a Ponzi scheme

Post by jbolden1517 » Fri Aug 25, 2017 10:54 am

Wakefield1 wrote:
Fri Aug 25, 2017 10:03 am
Was there a time when most stocks were held by individual investors,not institutions and mutual funds?
If memory serves household direct ownership went under 50% in 1989. I believe its still about as high as pension funds and mutual funds combined. The really big change since then is international ownership and hedge funds. If you just look at pension funds and mutual funds vs direct holdings the cross over was the late 1990s tech runup (which shifted assets towards mutual fund owners):

Image

More recently you have the problem of how to classify ETFs. You also have IMHO an increasing problem in measuring what you mean by "stock ownership" as individuals (especially young people) are holding stocks as parts of options portfolios insuring pension funds. For whom do you want to count that ownership?
Wakefield1 wrote:
Fri Aug 25, 2017 10:03 am
In such a time did active management work best since it was the presumably sophisticated fund manager vs. less sophisticated individual stock holders? (Playing the zero sum trading games or buying and holding)
Small growth and penny stocks are the area where individual speculators loved to get involved. Penny stocks are too illiquid for almost all mutual funds. Individuals did dreadfully in small growth, the broad market aggregates were pretty bad and mutual funds did rather well comparatively. If you exclude small growth I'm not aware of individual investors doing badly. Don't forget however a huge percentage of individual ownership are control investors. When it comes to knowledge of their companies control investors know vastly more than the mutual fund managers.
Wakefield1 wrote:
Fri Aug 25, 2017 10:03 am
Bogle seems to think that in the past mutual funds tended to do less trading than in the modern era,and I think he was talking about actively managed (stock holding) mutual funds. "stock swapping"
Trading costs used to be much higher. We should expect in a world of higher friction for there to be less trading. I wouldn't make much of this.
Wakefield1 wrote:
Fri Aug 25, 2017 10:03 am
to the people who fear that the large cap index has vastly overvalued and thus overweighted stocks,would using indexes such as the "midcap" or '"small cap value fund" reduce this disadvantage? (I confess that the last time I was about to send a check to "Index 500" I instead sent it to "Mid-Cap")
Yes. The biggest problems with indexing are in the bond market (especially Europe) Barclay's type bonds. The biggest in the stock market are in the SP500 where you have the most index investment. That being said though, there is no evidence that non-SP500 stocks in general are comparatively less valued. The only thing that doesn't seem kinda high is quality earnings companies, stocks with stable but not particularly fast growing or even slowly shrinking earnings and low debt levels so generating so-so ROE. The problem in the high P/E SP500 stocks though may go well beyond valuations. Index funds may because of float manipulation be effectively providing extremely cheap equity financing to these companies. That's essentially capital destruction not just overpaying some.

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Re: Passive investing is a Ponzi scheme

Post by nedsaid » Fri Aug 25, 2017 10:58 am

Another comment that I would like to make is that trading volumes on the exchanges have been going up and not down. This drives down bid/ask spreads, makes the markets more liquid, and contributes towards making the markets more efficient. One big problem, particularly for company management, is that since the average holding period for stocks has been decreasing, investor thinking gets to be shorter and shorter term. So company management is pressured to think quarter by quarter and not year by year or decade by decade. The big trend towards passive investing is a welcome change in that it encourages more long term thinking not only by investors but by company management. I just don't see how this is a bad thing.
A fool and his money are good for business.

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Re: Passive investing is a Ponzi scheme

Post by dwickenh » Fri Aug 25, 2017 11:07 am

"The assumption on Bogleheads is all of these people are lying."

Really? Everyone has an angle. It doesn't mean they are lying, it just means they gravitate to one side of the story. I prefer to hear both sides and then make a decision based on all of the known facts.
The market is the most efficient mechanism anywhere in the world for transferring wealth from impatient people to patient people.” | — Warren Buffett

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Re: Passive investing is a Ponzi scheme

Post by Jags4186 » Fri Aug 25, 2017 11:10 am

Active investing is more like an MLM scheme than a Ponzi scheme. The people at the top--Fund Managers--make money from everyone who joins. The next row of people--Advisors--make less than the Fund Managers, but still get their VIG when they convince people to invest in their firm. The people at the bottom--the investors--can get lucky and make money from the investments, but more likely than not they will lose out compared to the market.

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Re: Passive investing is a Ponzi scheme

Post by staythecourse » Fri Aug 25, 2017 11:44 am

jbolden1517 wrote:
Fri Aug 25, 2017 10:32 am
Value managers who are less concerned with market risk aren't complaining about a lack of alpha, they are finding plenty, but rather a low levels of long term beta.
Okay please cite the data to support positive alpha for value managers as a whole the last 10, 20, or 30 years. I may not be well informed as ALL the data I have seen is the chance of active management beating the benchmark is very low. Much thanks.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

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Re: Passive investing is a Ponzi scheme

Post by totality » Fri Aug 25, 2017 11:47 am

It does seem very plausible that a lot of the money flowing into index funds is not truly following a passive strategy, but rather is chasing returns in the current bull market. When there starts to be a correction, I would expect there to be a pullback on indexed money, which could drive the whole market down.

But I don't see how that's significantly different than if all the return chasers were in active funds or individual stocks, where presumably there would also be a selloff in a correction.

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Re: Passive investing is a Ponzi scheme

Post by staythecourse » Fri Aug 25, 2017 11:55 am

CantPassAgain wrote:
Fri Aug 25, 2017 10:16 am
staythecourse wrote:
Fri Aug 25, 2017 10:11 am
BTW, can anyone link a return message by Mr. Bogle in response to these new attacks?

Good luck.
I'm more interested as to what is going on behind the scenes that has caused this incredible onslaught at Bogleheads.org over the last month or so. Very curious.
Interesting as I was thinking the same thing. I would love to find out if there as been an uptick on new members joining last 3 months for so. It does seem (maybe me being me) that something is going on.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

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Re: Passive investing is a Ponzi scheme

Post by Jags4186 » Fri Aug 25, 2017 11:58 am

totality wrote:
Fri Aug 25, 2017 11:47 am
It does seem very plausible that a lot of the money flowing into index funds is not truly following a passive strategy, but rather is chasing returns in the current bull market. When there starts to be a correction, I would expect there to be a pullback on indexed money, which could drive the whole market down.

But I don't see how that's significantly different than if all the return chasers were in active funds or individual stocks, where presumably there would also be a selloff in a correction.
A pullback of money from index funds shouldn't affect the fund as long as the money goes into assets that are held in the fund.

For example, if $10,000,000,000 gets pulled from the S&P 500 at market cap weights, then $10,000,000,000 goes into Apple stock, the overall index shouldn't change even though the composition of the index would (apple would have a larger market cap and be a larger % of the index).

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Re: Passive investing is a Ponzi scheme

Post by JFP_SF » Fri Aug 25, 2017 12:00 pm

Jags4186 wrote:
Fri Aug 25, 2017 11:58 am
totality wrote:
Fri Aug 25, 2017 11:47 am
It does seem very plausible that a lot of the money flowing into index funds is not truly following a passive strategy, but rather is chasing returns in the current bull market. When there starts to be a correction, I would expect there to be a pullback on indexed money, which could drive the whole market down.

But I don't see how that's significantly different than if all the return chasers were in active funds or individual stocks, where presumably there would also be a selloff in a correction.
A pullback of money from index funds shouldn't affect the fund as long as the money goes into assets that are held in the fund.

For example, if $10,000,000,000 gets pulled from the S&P 500 at market cap weights, then $10,000,000,000 goes into Apple stock, the overall index shouldn't change even though the composition of the index would (apple would have a larger market cap and be a larger % of the index).
If people are pulling money out of index funds in a correction, they are extremely unlikely to invest it back into individual stocks.

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Re: Active investing is a Ponzi scheme

Post by Whakamole » Fri Aug 25, 2017 12:01 pm

jbolden1517 wrote:
Fri Aug 25, 2017 9:09 am
QQQ as a future and as an index was very big when I started on par with SPX among retail investors. When average people talked about "indexing" they often meant QQQ not TSM or SPX. So I've personally witnessed indexes go out of fashion with retail investors.
That is because at the time, QQQ was the tech index. Yes officially it was the Nasdaq 100 Index but the contents of the index were primarily tech companies:

http://etfdb.com/qqq-visual-history-of-the-nasdaq/

In 2000, the top holdings were Cisco, Microsoft, Intel, Oracle, Ericsson, Oracle America, Amgen, Qualcomm, Worldcom, and Dell. Only one of those companies, Amgen, was not a technology company. The QQQ was a non-diversified index focused on one sector, and had risks like any other sector-based index.

That is why we recommend broad-based index funds like TSM and S&P 500.

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Re: Passive investing is a Ponzi scheme

Post by Jags4186 » Fri Aug 25, 2017 12:04 pm

JFP_SF wrote:
Fri Aug 25, 2017 12:00 pm
Jags4186 wrote:
Fri Aug 25, 2017 11:58 am
totality wrote:
Fri Aug 25, 2017 11:47 am
It does seem very plausible that a lot of the money flowing into index funds is not truly following a passive strategy, but rather is chasing returns in the current bull market. When there starts to be a correction, I would expect there to be a pullback on indexed money, which could drive the whole market down.

But I don't see how that's significantly different than if all the return chasers were in active funds or individual stocks, where presumably there would also be a selloff in a correction.
A pullback of money from index funds shouldn't affect the fund as long as the money goes into assets that are held in the fund.

For example, if $10,000,000,000 gets pulled from the S&P 500 at market cap weights, then $10,000,000,000 goes into Apple stock, the overall index shouldn't change even though the composition of the index would (apple would have a larger market cap and be a larger % of the index).
If people are pulling money out of index funds in a correction, they are extremely unlikely to invest it back into individual stocks.
True, I'm just saying if for some reason active management becomes more popular and everyone decides to invest in American Funds Growth Fund or something like that instead of the TSM, it wouldn't really matter for an indexer as the active funds are just a subset of the TSM.

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Re: Passive investing is a Ponzi scheme

Post by Whakamole » Fri Aug 25, 2017 12:11 pm

totality wrote:
Fri Aug 25, 2017 11:47 am
It does seem very plausible that a lot of the money flowing into index funds is not truly following a passive strategy, but rather is chasing returns in the current bull market. When there starts to be a correction, I would expect there to be a pullback on indexed money, which could drive the whole market down.

But I don't see how that's significantly different than if all the return chasers were in active funds or individual stocks, where presumably there would also be a selloff in a correction.
Perhaps the return chasers with actively managed funds bought B-class shares, would balk at paying the 5% sales charge for selling, and would hold on?

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Re: Passive investing is a Ponzi scheme

Post by David Scubadiver » Fri Aug 25, 2017 12:12 pm

I agree that passive investing is a real problem. If everybody is invested in the index, than NOBODY cares about the individual companies, and when nobody cares and nobody is watching, bad things happen. Of course, nobody will know it happened because nobody will be paying attention.

Plus, how on earth can anything be "fairly valued" if nobody is looking at the fundamentals when they are buying the company, but instead the purchase is made simply because the company exists and is in the index?

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Re: Active investing is a Ponzi scheme

Post by BolderBoy » Fri Aug 25, 2017 12:33 pm

jbolden1517 wrote:
Fri Aug 25, 2017 8:10 am
gregchesney wrote:
Fri Aug 25, 2017 6:46 am
matjen wrote:
Fri Aug 25, 2017 6:36 am
That whole interview was little more than a word salad.
I agree but I was astonished at the carelessness of her rhetoric.
The belief is that Indexing is somehow a unique trading strategy and unlike the countless other examples of trading strategies that got popular and caused distortion.
Ummmm, isn't indexing in fact a non-trading strategy?
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Re: Passive investing is a Ponzi scheme

Post by Da5id » Fri Aug 25, 2017 12:37 pm

David Scubadiver wrote:
Fri Aug 25, 2017 12:12 pm
I agree that passive investing is a real problem. If everybody is invested in the index, than NOBODY cares about the individual companies, and when nobody cares and nobody is watching, bad things happen. Of course, nobody will know it happened because nobody will be paying attention.

Plus, how on earth can anything be "fairly valued" if nobody is looking at the fundamentals when they are buying the company, but instead the purchase is made simply because the company exists and is in the index?
Anything that can't go on forever won't. If "everyone" indexing leads to mispricing of stocks, enough investors won't index to exploit that, resulting in something like correct relative pricing of stocks.

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Re: Active investing is a Ponzi scheme

Post by jbolden1517 » Fri Aug 25, 2017 12:39 pm

nedsaid wrote:
Fri Aug 25, 2017 10:47 am
jbolden1517 wrote:
Fri Aug 25, 2017 8:10 am

Why? She runs a value house and manages some value funds. She has a lot of funds that trade in illiquid parts of stock markets. She sees wide spreads everyday when stocks have fallen hard. She believes in buying stocks based on their fundamentals. Indexers believe in buying stocks based on their floats deliberately ignoring all fundamentals. Why wouldn't you expect her to see your approach as reckless and destructive?
Nedsaid: For one thing, active management is not dead.
You and I already had this conversation. BofA estimated for SP500 passive + quasi-indexing was 70%. JPMorgan agreed that 70% of trades from non-arbitrage investors were passive, or about 16% of all trades were based on fundamentals of any kind. To use Bogle's analogy whole life insurance isn't dead but it is mostly irrelevant to pricing today's market. Closed end funds in most areas have no impact while 80 years ago they were big players. Active funds aren't dead but they are getting weak enough that they can't meaningfully control the market.
nedsaid wrote:
Fri Aug 25, 2017 10:47 am
My guess is that active management will lose a lot of market share but at some point that will stabilize. Even if active management went away, which it won't, you still have all the factor funds out there.
Agree. IMHO that is the next place the money flows into. Incidentally that's BofA's position as well. The distortions created by indexing aren't exploitable in a 3 year window they are in 10-20 yr windows. I think as those guys become dominant the world gets much easier for active.
nedsaid wrote:
Fri Aug 25, 2017 10:47 am
Pretty much, the academics are like the cavalry coming in to rescue market efficiency and the factor funds like DFA will make certain market inefficiencies are captured.
I'm not that optimistic and my longs are mostly in factor funds. I think the big problem with factor funds is they don't look at obvious near term information but they trade heavily on recent past information. Opposite a market dominated by factor funds classic 6-18 mo projections become an extremely effective strategy. Every strategy has counter strategies.
nedsaid wrote:
Fri Aug 25, 2017 10:47 am
Also you have the professional traders, arbitrageurs, shareholder activists, hedge funds, flash traders, the leverage buy-out people out there and they aren't going away. There will always be people out there who will make the markets efficient. And don't forget the robots.
The LBO people I agree are a long term source of efficiency that indexing is likely helping (by providing inexpensive financing for LBOs). Not so much yet, but this is a likely future outcome especially if indexing thrives for many years.

Arbitrage is thriving. No doubt relative valuation tricks between markets are getting more efficient. But the purposes of these markets are quite different. The more markets are efficiently priced between each other it becomes quite possible that they become less efficient within each other. For example the volatility futures -> SP500 stock options -> stock prices may eliminate the contango in the futures market and at the same time substantially erode the a percent of two of the return that stock investors are investing in stocks to get. But that's a different a problem.

I'm not sure what a flash trader is.

Hedge funds... don't really know what their impact will be.
nedsaid wrote:
Fri Aug 25, 2017 10:47 am
jbolden1517 wrote:
Fri Aug 25, 2017 8:10 am

We now have hundreds if not thousands of market professionals coming forward and saying float trading is breaking the ability of the stock market to accurately price assets either in relative or absolute terms. We have hundreds of market professionals coming forward and saying that float trading has completely distorted the bond market and it isn't merely breaking it is broken (btw Bogle himself is one of these with regard to the Barclay's index which is the one used by Vanguard). We have dozens of market professionals coming forward and talking about how passive investing is shifting internal corporate finance in ways that are potentially highly destructive to long term equity returns both in terms of corporate leverage and dilution financing.
Nedsaid: I think there is a point here but it is overstated. The lady mentioned lack of liquidity in markets when everyone wants to sell, but that would be even more of a problem for an active manager who is holding stocks that are less liquid. Pretty much, when everybody hits the exits at the same time, price has to drop enough to where buyers are willing to come in and buy albeit at a greatly reduced price. This has always been a problem in the markets, not sure indexing has contributed to it.
Agreed. Her assumption (I assume) is that the buying in high P/E SP500 stocks (like FANG) is concentrated more in index funds than active. This problem isn't evenly distributed. We've talked about the incentives for float manipulation and how this creates discrepancies between official float and actual float.

nedsaid wrote:
Fri Aug 25, 2017 10:47 am

There is the argument that indexing distorts the markets, buying stocks regardless of valuations. My guess is that if this was happening that the Value premium, or at least the future expected returns of Value stocks, would greatly increase. I see no evidence this is happening.
Relative to growth stocks, yes that's what you would see. What evidence would you expect to see at this point if it were happening that you aren't seeing?
nedsaid wrote:
Fri Aug 25, 2017 10:47 am
jbolden1517 wrote:
Fri Aug 25, 2017 8:10 am

The assumption on Bogleheads is all of these people are lying. The belief is that Indexing is somehow a unique trading strategy and unlike the countless other examples of trading strategies that got popular and caused distortion. It is assumed that nothing like that could ever possibly happen and certainly not at a mere 95% of net inflows some months. When one points to examples in particular stocks where it obviously is happening it is ignored because of course it is impossible so why look at evidence? In the interview she did mention specific examples of where she felt the risk in indexing were particularly acute with the FANG stocks vs. stocks like Microsoft where you get the same growth at more reasonable valuations. Pretty standard GARP ideology, doing relative industry and sector valuation. The sort of thing that indexers often claim to support when they argue they aren't buying random stocks at random prices. She's not saying anything unusual at all.
If markets started getting inefficient, I suppose the standard advice around here would no longer be to invest 100% passive but perhaps 70% passive indexes and 30% factor funds or low cost active management. It would sort of be like a sacrifice to the trading Gods, buy enough active management to keep the rest of the market efficient. Paying dues to the efficient markets club.
If markets started getting inefficient with respect to indexing it would look something like
a) There is a period of time when indexes are underperforming mutual funds in the same market. I suspect there would be a period of likely years where there was denial this was happening. If there wasn't a sharp correct during these years this likely would be followed by a period of excuses this was an isolated problem.

b) But I think there is a bear several years into it. As outflows increase from cap weighted and quasi cap weighted vehicles the market starts to sharply correct. The issue then becomes "what is best to do now". And here it becomes very murky. While indexing was a bad idea at the top, as other strategies get adopted this undercuts the effectiveness of counter indexing strategies (except for concentration plays) and I suspect the passive fund all adjust perhaps by lagging changes in float for years. Also they do something about counter patient-buyer patient-seller possibly by making their market buy / sells more slightly more random.

c) The inflows go into a new strategy which creates alternative inefficiencies. I'm suspect factor weightings. At this point cap-weighting goes back to being just one strategy among many. The other strategies outperform because they like all strategies they benefit from momentum effects. So indexing continues to lag other passive strategies. This creates further outflows but they are less impactful to the market broadly than they were in (b).

d) The outflows cease to matter and cap weighted Indexing works well for many years when no one is paying attention.

e) cap weighted indexing comes back in fashion due to decades of outperformance.

nedsaid wrote:
Fri Aug 25, 2017 10:47 am

So far, the evidence is that indexing has not distorted the markets. I think Mr. Bogle believes that your need only 20% active to keep the rest of the market efficient. I just have a hard time believing that indexing in itself is setting market prices. Another thing is that the good indexers are also really good traders and we are seeing the use of patient trading strategies to alleviate the problem of indexing itself affecting prices either on the upside or the downside. One example is that they are aware of the traders front-running the indexes and the indexers have taken steps to reduce the drag from front running.
Agree on front running. Patient trading is becoming a source of drag, it was quite effective in the 1990s. As for not setting prices. I'm hearing to many credible people claim it and I've experienced several times in stocks I do trade. I'm over my evidence hump. I'd like more confirmation but at this point across the board I'm avoiding cap weighting whenever possible.

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Re: Passive investing is a Ponzi scheme

Post by saltycaper » Fri Aug 25, 2017 12:45 pm

staythecourse wrote:
Fri Aug 25, 2017 11:55 am
CantPassAgain wrote:
Fri Aug 25, 2017 10:16 am
staythecourse wrote:
Fri Aug 25, 2017 10:11 am
BTW, can anyone link a return message by Mr. Bogle in response to these new attacks?

Good luck.
I'm more interested as to what is going on behind the scenes that has caused this incredible onslaught at Bogleheads.org over the last month or so. Very curious.
Interesting as I was thinking the same thing. I would love to find out if there as been an uptick on new members joining last 3 months for so. It does seem (maybe me being me) that something is going on.

Good luck.
Don't worry. Sometimes the best strategy is just to let opponents keep talking. If their argument is without merit, the more they keep talking, the more chinks are revealed in their reasoning. Also, it could be simply that it's August, and people have better things to do than re-hash tired debates on an Internet forum. :happy
"I guess I should warn you, if I turn out to be particularly clear, you've probably misunderstood what I've said." --Alan Greenspan

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Re: Passive investing is a Ponzi scheme

Post by jbolden1517 » Fri Aug 25, 2017 12:45 pm

nedsaid wrote:
Fri Aug 25, 2017 10:58 am
Another comment that I would like to make is that trading volumes on the exchanges have been going up and not down. This drives down bid/ask spreads, makes the markets more liquid, and contributes towards making the markets more efficient. One big problem, particularly for company management, is that since the average holding period for stocks has been decreasing, investor thinking gets to be shorter and shorter term. So company management is pressured to think quarter by quarter and not year by year or decade by decade. The big trend towards passive investing is a welcome change in that it encourages more long term thinking not only by investors but by company management. I just don't see how this is a bad thing.
I think it is a great thing. Don't confuse believing cap weighted indexing has some problems with believing that the old regime of 6-18 mo earnings didn't have equal or larger problems. There is a lot about the indexing revolution that is extremely positive.

IMHO the biggest positive has been selling concentration for large cap stocks and thus the swing in 2012 towards relative dividend yield finally increasing. Given the high valuations, low interest rates and bad demographics earnings growth may not generate enough return for stock investors. But a move from 20% payouts to 60% payouts over 40 years is 2.7% extra return per year for stock investors. Its obviously a one time boost, but a one time boost that covers my investment horizon. i have indexers to thank for that.

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Re: Passive investing is a Ponzi scheme

Post by David Scubadiver » Fri Aug 25, 2017 12:52 pm

Da5id wrote:
Fri Aug 25, 2017 12:37 pm
David Scubadiver wrote:
Fri Aug 25, 2017 12:12 pm
I agree that passive investing is a real problem. If everybody is invested in the index, than NOBODY cares about the individual companies, and when nobody cares and nobody is watching, bad things happen. Of course, nobody will know it happened because nobody will be paying attention.

Plus, how on earth can anything be "fairly valued" if nobody is looking at the fundamentals when they are buying the company, but instead the purchase is made simply because the company exists and is in the index?
Anything that can't go on forever won't. If "everyone" indexing leads to mispricing of stocks, enough investors won't index to exploit that, resulting in something like correct relative pricing of stocks.
That is only correct if there are enough active investors participating in the market. If 99 people don't care what the price is (because they are passively investing) and 1 person determines the stock is underpriced by 10%, that 1 person can do nothing to profit because 99 people don't care what he sees. If we are at 98 and 2, the 2 can get into a lovely negotiation over the relative value of the stock, but there are still not enough people to make an actual market or an actual difference to the market price of the stock.

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Re: Active investing is a Ponzi scheme

Post by jbolden1517 » Fri Aug 25, 2017 12:55 pm

BolderBoy wrote:
Fri Aug 25, 2017 12:33 pm
jbolden1517 wrote:
Fri Aug 25, 2017 8:10 am

The belief is that Indexing is somehow a unique trading strategy and unlike the countless other examples of trading strategies that got popular and caused distortion.
Ummmm, isn't indexing in fact a non-trading strategy?
Nope. Index funds don't get their stocks from the stock fairy. Excluding the making market stuff for simplicity. During periods of inflows like any fund they have to decide which stocks to buy at which prices. How they decide that is a trading strategy. They way index funds decide what to buy they they create targets allocations based on the stock's reported float. They then slowly adjust their buy range up until they hit their or slightly exceed their targets. Given persistent inflows (what they are experiencing) and reinvestment of dividends this means they collectively form a huge group of float traders hitting the market with buy orders. A huge group of buyers indifferent to fundamentals but passionate interested in changes to reported float.

Since on any given day
dollars to buy stock X / share of stock X for sale = price for share X; if there are huge groups of buyers trading reported floats on the buy side but not on the sell side price starts correlating strongly with changes in reported float not fundamentals.

Of course there are some counter forces, sellers who are interested in fundamentals can respond to these price changes by selling. But after a certain point their stocks are sold and their ability to further influence price without shorting is gone. Control investors can of course change reported float. For them the stock price is a vehicle to generate return, not their definition of return.

Sorry to break it to you. You are part of the market. You don't sit above it in some bubble looking down at the other participants. How you trade effects price.

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Re: Passive investing is a Ponzi scheme

Post by peterinjapan » Fri Aug 25, 2017 12:57 pm

Eventually we'll all be indexing, and there'll be one guy named Ned, moving the market this way and that with his trades. It will be hilarious to watch.

Jocularity aside, does anybody else think that the "smoothness" of the current bull market was in part enabled by the large number of indexers? I'm sure it has to be a factor.

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Re: Passive investing is a Ponzi scheme

Post by Whakamole » Fri Aug 25, 2017 12:59 pm

peterinjapan wrote:
Fri Aug 25, 2017 12:57 pm
Eventually we'll all be indexing, and there'll be one guy named Ned, moving the market this way and that with his trades. It will be hilarious to watch.

Jocularity aside, does anybody else think that the "smoothness" of the current bull market was in part enabled by the large number of indexers? I'm sure it has to be a factor.
I don't think this run has been any smoother than previous bull markets: http://www.multpl.com/s-p-500-historical-prices

Compare the run up to Black Monday - or the bull market after for that matter.

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