Larry Swedroe: New Passive Criticism Fails

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Larry Swedroe: New Passive Criticism Fails

Post by Random Walker » Wed Sep 13, 2017 9:17 am

http://www.etf.com/sections/index-inves ... cism-fails

In this article Larry describes one argument made against passive investing and refutes it. The argument is basically that as more and more people index, there is less and less price discovery by hedge funds and active traders. This should create room for hedge funds and active funds to take advantage of inefficiencies. There's only one problem with this rationale: the data completely contradicts it!

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Re: Larry Swedroe: New Passive Criricism Fails

Post by nisiprius » Wed Sep 13, 2017 10:15 am

Have supermarkets been destroyed by millions of customers passively paying the amount printed on the price label, instead of stopping to haggle over each purchase and negotiate a price on each item?
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Re: Larry Swedroe: New Passive Criricism Fails

Post by nedsaid » Wed Sep 13, 2017 10:22 am

There could be a point at which too much indexing causes problems in the markets but if that ever happens, it would be a long, long ways off. The evidence is pointing to greater and greater efficiency in the markets and not less. Also, the factor investing espoused by academics should pick up any slack left by the active funds. The hedge funds, shareholder activists, the leveraged buy-out people, the professional traders have not and will not go away. Human nature doesn't change, I suspect the "animal spirits" that John Maynard Keynes talked about will be around as long as humans are around.
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Re: Larry Swedroe: New Passive Criricism Fails

Post by avalpert » Wed Sep 13, 2017 10:25 am

nisiprius wrote:
Wed Sep 13, 2017 10:15 am
Have supermarkets been destroyed by millions of customers passively paying the amount printed on the price label, instead of stopping to haggle over each purchase and negotiate a price on each item?
I don't think the analogy works unless you are assuming that grocery shoppers buy their groceries without regard for the prices offered by sellers. The passive/active discussion isn't about haggling over price, it is about whether you come in with your own notion of the value or you will buy/sell at whatever price is offered.

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Re: Larry Swedroe: New Passive Criricism Fails

Post by deltaneutral83 » Wed Sep 13, 2017 11:02 am

Price discovery is something I'll pay attention to when indexing represents 75% of the market. We've had an incredible wave of outflows into indexing the last 15 years and I don't even think we're up to 40%.

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Re: Larry Swedroe: New Passive Criricism Fails

Post by NateH » Wed Sep 13, 2017 11:32 am

If any of these criticisms start to actually work, they will be quietly arbitraged out :moneybag before anyone gets to write articles and give testimony to regulators. My feeling is it wouldn't take very many active participants to keep pricing efficient, considering their motivation is to make money.
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Re: Larry Swedroe: New Passive Criricism Fails

Post by JBTX » Wed Sep 13, 2017 12:34 pm

Intuitively, if a greater amount of people (passive investors) are simply replicating what a smaller and smaller share are doing (active), one would think at some point that will have an impact. But actually acting / benefiting on that impact is infinitely harder, or impossible to do.

Theoretically, you would think the trades of active traders would have a magnified impact on the market. If 1/2 of the market is passive, then one active investor selling a stock is essentially two total investors selling it. But I have no idea how concentrated and how small the active subset would have to be for this to have a noticeable impact.

I chalk it up as yet another thing that just changes the way the market behaves somewhat. Automated and program trading changed things. Rapid electronic supercomputer changed things. In some ways good, in some ways bad. Ultimately for the buy and hold investor it should have little impact.

One psychological impact that index funds have, is even active fund managers will often try to mostly follow the index. They can't risk getting clobbered to badly by the index.

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Re: Larry Swedroe: New Passive Criricism Fails

Post by tmsul100 » Wed Sep 13, 2017 12:52 pm

nisiprius wrote:
Wed Sep 13, 2017 10:15 am
Have supermarkets been destroyed by millions of customers passively paying the amount printed on the price label, instead of stopping to haggle over each purchase and negotiate a price on each item?
That's a really smart point.

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Re: Larry Swedroe: New Passive Criticism Fails

Post by Random Walker » Wed Sep 13, 2017 1:19 pm

Actually, I believe the supermarket comparison is not appropriate. There is daily competition between the supermarkets on price, just as there is daily competition between active traders on price. In both cases, price is set at the margin and us end consumers accept the price, whether it's groceries or stocks. Consumers passively accepting the grocery price at one store is not the issue.

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Re: Larry Swedroe: New Passive Criticism Fails

Post by Fallible » Wed Sep 13, 2017 1:20 pm

If only active management would stop picking on passive and just lower its fees ...

Thanks for the link. I liked this perspective from Larry (the numbers are almost amusing):
Clearly, we aren’t at the point where markets have become inefficient due to a lack of price discovery efforts. But that might lead one to ask: At what point will there not be sufficient managers analyzing stocks to ensure prices are the best estimate of the right price?

While I don’t think anyone knows the answer to that question, surely it’s far less than the tens of thousands of managers we have today. Perhaps even a few hundred would be enough.

In fact, it wasn’t until 1950 when the number of mutual funds topped 100. That number was still only at about 150 in 1960. And we didn’t seem to have any problems allocating capital and setting prices efficiently then. Today we have more than 9,000 mutual funds and probably more than 10,000 hedge funds. Do investors really need all those active managers to ensure capital is allocated efficiently? It doesn’t seem likely.
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Re: Larry Swedroe: New Passive Criricism Fails

Post by avalpert » Wed Sep 13, 2017 2:39 pm

JBTX wrote:
Wed Sep 13, 2017 12:34 pm
Theoretically, you would think the trades of active traders would have a magnified impact on the market. If 1/2 of the market is passive, then one active investor selling a stock is essentially two total investors selling it.

I don't think that is right, theoretically. Why would the weight of an individual sale be magnified because of the volume of shares held by passive investors? It only takes two active investors with different views of the price to cause price discovery and it is irrespective of what percent of shares they represent.

There may be something about the argument that makes intuitive sense, but with even a little scrutiny I think it falls apart quickly.
One psychological impact that index funds have, is even active fund managers will often try to mostly follow the index. They can't risk getting clobbered to badly by the index.
It isn't the existence of index funds, it is the existence of an index or any other benchmark at all. Yes, it is safer for them to be around the crowd then to risk being below it - regardless of the existence of passive investors.

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Re: Larry Swedroe: New Passive Criricism Fails

Post by JBTX » Wed Sep 13, 2017 2:51 pm

avalpert wrote:
Wed Sep 13, 2017 2:39 pm
JBTX wrote:
Wed Sep 13, 2017 12:34 pm
Theoretically, you would think the trades of active traders would have a magnified impact on the market. If 1/2 of the market is passive, then one active investor selling a stock is essentially two total investors selling it.

I don't think that is right, theoretically. Why would the weight of an individual sale be magnified because of the volume of shares held by passive investors? It only takes two active investors with different views of the price to cause price discovery and it is irrespective of what percent of shares they represent.

There may be something about the argument that makes intuitive sense, but with even a little scrutiny I think it falls apart quickly.
One psychological impact that index funds have, is even active fund managers will often try to mostly follow the index. They can't risk getting clobbered to badly by the index.
It isn't the existence of index funds, it is the existence of an index or any other benchmark at all. Yes, it is safer for them to be around the crowd then to risk being below it - regardless of the existence of passive investors.
Let's say Buffett and Soros were the only 2 active investors and their stakes were 1% of the total equity market. The other 99% were all passive. So whenever Buffett and soros engage in a transaction it has a magnified effect, does it not? The less active investors the less liquid a market is, which can cause more irratic and exaggerated price movements.

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Re: Larry Swedroe: New Passive Criricism Fails

Post by avalpert » Wed Sep 13, 2017 3:17 pm

JBTX wrote:
Wed Sep 13, 2017 2:51 pm
avalpert wrote:
Wed Sep 13, 2017 2:39 pm
JBTX wrote:
Wed Sep 13, 2017 12:34 pm
Theoretically, you would think the trades of active traders would have a magnified impact on the market. If 1/2 of the market is passive, then one active investor selling a stock is essentially two total investors selling it.

I don't think that is right, theoretically. Why would the weight of an individual sale be magnified because of the volume of shares held by passive investors? It only takes two active investors with different views of the price to cause price discovery and it is irrespective of what percent of shares they represent.

There may be something about the argument that makes intuitive sense, but with even a little scrutiny I think it falls apart quickly.
One psychological impact that index funds have, is even active fund managers will often try to mostly follow the index. They can't risk getting clobbered to badly by the index.
It isn't the existence of index funds, it is the existence of an index or any other benchmark at all. Yes, it is safer for them to be around the crowd then to risk being below it - regardless of the existence of passive investors.
Let's say Buffett and Soros were the only 2 active investors and their stakes were 1% of the total equity market. The other 99% were all passive. So whenever Buffett and soros engage in a transaction it has a magnified effect, does it not?
No, it doesn't. It has the same affect as a trade does today - two parties set the current valuation for everyone.
The less active investors the less liquid a market is,
Not true either - passive funds provide plenty of liquidity, just not active price discovery. Vanguard does like $2 billion in trades a day last time I saw a number.
which can cause more irratic and exaggerated price movements.
That may be true, not because of less liquidity but because of less frequent price discovery leading to bigger jumps - but this is where the whole suspension of economics takes place in the story, if there is money to be made stepping into the void between those jumps someone will do it. And with the ample liquidity provided by passive investors, it is relatively easy for the active traders to jump in.

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Re: Larry Swedroe: New Passive Criricism Fails

Post by JBTX » Wed Sep 13, 2017 3:26 pm

avalpert wrote:
Wed Sep 13, 2017 3:17 pm
JBTX wrote:
Wed Sep 13, 2017 2:51 pm
avalpert wrote:
Wed Sep 13, 2017 2:39 pm
JBTX wrote:
Wed Sep 13, 2017 12:34 pm
Theoretically, you would think the trades of active traders would have a magnified impact on the market. If 1/2 of the market is passive, then one active investor selling a stock is essentially two total investors selling it.

I don't think that is right, theoretically. Why would the weight of an individual sale be magnified because of the volume of shares held by passive investors? It only takes two active investors with different views of the price to cause price discovery and it is irrespective of what percent of shares they represent.

There may be something about the argument that makes intuitive sense, but with even a little scrutiny I think it falls apart quickly.
One psychological impact that index funds have, is even active fund managers will often try to mostly follow the index. They can't risk getting clobbered to badly by the index.
It isn't the existence of index funds, it is the existence of an index or any other benchmark at all. Yes, it is safer for them to be around the crowd then to risk being below it - regardless of the existence of passive investors.
Let's say Buffett and Soros were the only 2 active investors and their stakes were 1% of the total equity market. The other 99% were all passive. So whenever Buffett and soros engage in a transaction it has a magnified effect, does it not?
No, it doesn't. It has the same affect as a trade does today - two parties set the current valuation for everyone.
But I think I am saying the same thing you are saying below in terms of price discovery. If Buffett owns security X at $50, and wants to sell it at $49, now he can probably do it. But if Soros is his only trading partner, Soros may only take it for $30. The result is Buffett sits on it until he really wants to dump it, and a huge price drop.


The less active investors the less liquid a market is,
Not true either - passive funds provide plenty of liquidity, just not active price discovery. Vanguard does like $2 billion in trades a day last time I saw a number.
Are the passive investors really active participants? They are just doing what everybody else is doing - apart from some new money coming into the market or leaving the market in general.
which can cause more irratic and exaggerated price movements.
That may be true, not because of less liquidity but because of less frequent price discovery leading to bigger jumps - but this is where the whole suspension of economics takes place in the story, if there is money to be made stepping into the void between those jumps someone will do it. And with the ample liquidity provided by passive investors, it is relatively easy for the active traders to jump in.
[/quote]

But there are less active investors jumping in to find the mispricings, correct?

Granted, it is mostly a theoretical argument, and practically in the real world I don't know that it will make a difference, but at some point, if most of the investors are just copying what a small portion of investors are doing, that has to have an effect on the overall behavior of the market...does it not?

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Re: Larry Swedroe: New Passive Criricism Fails

Post by nedsaid » Wed Sep 13, 2017 3:34 pm

JBTX wrote:
Wed Sep 13, 2017 2:51 pm

Let's say Buffett and Soros were the only 2 active investors and their stakes were 1% of the total equity market. The other 99% were all passive. So whenever Buffett and soros engage in a transaction it has a magnified effect, does it not? The less active investors the less liquid a market is, which can cause more irratic and exaggerated price movements.
Just imagine watching Nightly Business Report and Tyler Mathisen announces that only 100 shares traded that day. Me selling 100 shares of XYZ stock to somebody else. Nice to joke about but in real life younger people would be buying for their retirement and retirees would be selling to pay bills. So there would always be some volume. But I supposed if everybody indexed and then bought, held, and rebalanced, the financial shows would be very dull indeed.

The fact is it is human nature to want to be above average. To a degree, people are pouring money into index funds because individuals have noticed their superior performance, there is a tad bit of performance chasing going on here. At some point, there will be an equilibrium point between active and passive as some people will continue to want the hope of above average returns. The paradox is that average returns from index funds will get above average returns compared to investors as a whole simply because of the very low costs of indexing. Investors as a whole get market returns minus expenses. If indexers get market returns for miniscule expenses, it is worse than a zero sum gain for the active investors. Active investors as a group will always do worse than indexers as a group because active has higher management fees and trading costs than indexers. There will always be a group of people who either don't grasp this or who still think they can beat the odds.

I don't think indexing will cause illiquidity in the rest of the market unless almost everybody decides to index. The thing is, the mutual fund industry is pretty unlikely to shrink from 9,000 funds to 150 funds. The hedge fund industry is unlikely to go away. There are always traders and speculators among us. Odds are pretty strong that active management won't go away. Even if active management went away, you still have the academic research and factor investing.
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Re: Larry Swedroe: New Passive Criricism Fails

Post by avalpert » Wed Sep 13, 2017 3:36 pm

JBTX wrote:
Wed Sep 13, 2017 3:26 pm
avalpert wrote:
Wed Sep 13, 2017 3:17 pm
JBTX wrote:
Wed Sep 13, 2017 2:51 pm
avalpert wrote:
Wed Sep 13, 2017 2:39 pm
JBTX wrote:
Wed Sep 13, 2017 12:34 pm
Theoretically, you would think the trades of active traders would have a magnified impact on the market. If 1/2 of the market is passive, then one active investor selling a stock is essentially two total investors selling it.

I don't think that is right, theoretically. Why would the weight of an individual sale be magnified because of the volume of shares held by passive investors? It only takes two active investors with different views of the price to cause price discovery and it is irrespective of what percent of shares they represent.

There may be something about the argument that makes intuitive sense, but with even a little scrutiny I think it falls apart quickly.
One psychological impact that index funds have, is even active fund managers will often try to mostly follow the index. They can't risk getting clobbered to badly by the index.
It isn't the existence of index funds, it is the existence of an index or any other benchmark at all. Yes, it is safer for them to be around the crowd then to risk being below it - regardless of the existence of passive investors.
Let's say Buffett and Soros were the only 2 active investors and their stakes were 1% of the total equity market. The other 99% were all passive. So whenever Buffett and soros engage in a transaction it has a magnified effect, does it not?
No, it doesn't. It has the same affect as a trade does today - two parties set the current valuation for everyone.
But I think I am saying the same thing you are saying below in terms of price discovery. If Buffett owns security X at $50, and wants to sell it at $49, now he can probably do it. But if Soros is his only trading partner, Soros may only take it for $30. The result is Buffett sits on it until he really wants to dump it, and a huge price drop.
Except, while they may be the only two price setters they aren't the only buyers/sellers. So some fund comes in looking to by shares as close to the closing price as possible and Buffett steps up to sell at $49, another fund needs to sell shares and Soros is willing to buy at $30 - or maybe the market maker steps in and connects these passive buyer/sellers at a price in between and Buffett and Soros need to adjust their views.

The less active investors the less liquid a market is,
Not true either - passive funds provide plenty of liquidity, just not active price discovery. Vanguard does like $2 billion in trades a day last time I saw a number.
Are the passive investors really active participants? They are just doing what everybody else is doing - apart from some new money coming into the market or leaving the market in general.
Yes, they are active participants in the sense that they actively execute lots of trading volume. Try to find one of the articles out there that goes behind the scenes into their trading floors to get a sense for what a day looks like, it is not a passive exercise.
which can cause more irratic and exaggerated price movements.
That may be true, not because of less liquidity but because of less frequent price discovery leading to bigger jumps - but this is where the whole suspension of economics takes place in the story, if there is money to be made stepping into the void between those jumps someone will do it. And with the ample liquidity provided by passive investors, it is relatively easy for the active traders to jump in.
But there are less active investors jumping in to find the mispricings, correct?[/quote]
I'm not sure there are. There may be a lower percentage of the volume being held by active investors - but that doesn't mean there are fewer active investors or even less absolute dollars behind them than say 10 years ago.
Granted, it is mostly a theoretical argument, and practically in the real world I don't know that it will make a difference, but at some point, if most of the investors are just copying what a small portion of investors are doing, that has to have an effect on the overall behavior of the market...does it not?
I'm not sure it does until true extremes (like nearly 100%). Think of passive investors more like the water riding a wave and the active investors are the wind or gravitational force that initiate the wave and determine its energy. There is plenty of capacity for the water to serve as the medium through which the action moves.

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Re: Larry Swedroe: New Passive Criricism Fails

Post by JBTX » Wed Sep 13, 2017 4:02 pm

nedsaid wrote:
Wed Sep 13, 2017 3:34 pm
JBTX wrote:
Wed Sep 13, 2017 2:51 pm

Let's say Buffett and Soros were the only 2 active investors and their stakes were 1% of the total equity market. The other 99% were all passive. So whenever Buffett and soros engage in a transaction it has a magnified effect, does it not? The less active investors the less liquid a market is, which can cause more irratic and exaggerated price movements.
Just imagine watching Nightly Business Report and Tyler Mathisen announces that only 100 shares traded that day. Me selling 100 shares of XYZ stock to somebody else. Nice to joke about but in real life younger people would be buying for their retirement and retirees would be selling to pay bills. So there would always be some volume. But I supposed if everybody indexed and then bought, held, and rebalanced, the financial shows would be very dull indeed.

The fact is it is human nature to want to be above average. To a degree, people are pouring money into index funds because individuals have noticed their superior performance, there is a tad bit of performance chasing going on here. At some point, there will be an equilibrium point between active and passive as some people will continue to want the hope of above average returns. The paradox is that average returns from index funds will get above average returns compared to investors as a whole simply because of the very low costs of indexing. Investors as a whole get market returns minus expenses. If indexers get market returns for miniscule expenses, it is worse than a zero sum gain for the active investors. Active investors as a group will always do worse than indexers as a group because active has higher management fees and trading costs than indexers. There will always be a group of people who either don't grasp this or who still think they can beat the odds.

I don't think indexing will cause illiquidity in the rest of the market unless almost everybody decides to index. The thing is, the mutual fund industry is pretty unlikely to shrink from 9,000 funds to 150 funds. The hedge fund industry is unlikely to go away. There are always traders and speculators among us. Odds are pretty strong that active management won't go away. Even if active management went away, you still have the academic research and factor investing.
I agree with all that.

I think some people mistake my contemplation of the side effects of passive investing as being a detractor from such strategy. That isn't the case.

You are right and I think it was Buffett who said passive and active investors by definition will make the same thing, except for fees, thus by definition passive investors will beat a majority of active investors.

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Re: Larry Swedroe: New Passive Criricism Fails

Post by JBTX » Wed Sep 13, 2017 4:12 pm

avalpert wrote:
Wed Sep 13, 2017 3:36 pm
JBTX wrote:
Wed Sep 13, 2017 3:26 pm
avalpert wrote:
Wed Sep 13, 2017 3:17 pm
JBTX wrote:
Wed Sep 13, 2017 2:51 pm


Let's say Buffett and Soros were the only 2 active investors and their stakes were 1% of the total equity market. The other 99% were all passive. So whenever Buffett and soros engage in a transaction it has a magnified effect, does it not?
No, it doesn't. It has the same affect as a trade does today - two parties set the current valuation for everyone.
But I think I am saying the same thing you are saying below in terms of price discovery. If Buffett owns security X at $50, and wants to sell it at $49, now he can probably do it. But if Soros is his only trading partner, Soros may only take it for $30. The result is Buffett sits on it until he really wants to dump it, and a huge price drop.
Except, while they may be the only two price setters they aren't the only buyers/sellers. So some fund comes in looking to by shares as close to the closing price as possible and Buffett steps up to sell at $49, another fund needs to sell shares and Soros is willing to buy at $30 - or maybe the market maker steps in and connects these passive buyer/sellers at a price in between and Buffett and Soros need to adjust their views.

The less active investors the less liquid a market is,
Not true either - passive funds provide plenty of liquidity, just not active price discovery. Vanguard does like $2 billion in trades a day last time I saw a number.
Are the passive investors really active participants? They are just doing what everybody else is doing - apart from some new money coming into the market or leaving the market in general.
Yes, they are active participants in the sense that they actively execute lots of trading volume. Try to find one of the articles out there that goes behind the scenes into their trading floors to get a sense for what a day looks like, it is not a passive exercise.
which can cause more irratic and exaggerated price movements.
That may be true, not because of less liquidity but because of less frequent price discovery leading to bigger jumps - but this is where the whole suspension of economics takes place in the story, if there is money to be made stepping into the void between those jumps someone will do it. And with the ample liquidity provided by passive investors, it is relatively easy for the active traders to jump in.
But there are less active investors jumping in to find the mispricings, correct?
I'm not sure there are. There may be a lower percentage of the volume being held by active investors - but that doesn't mean there are fewer active investors or even less absolute dollars behind them than say 10 years ago.
Granted, it is mostly a theoretical argument, and practically in the real world I don't know that it will make a difference, but at some point, if most of the investors are just copying what a small portion of investors are doing, that has to have an effect on the overall behavior of the market...does it not?
I'm not sure it does until true extremes (like nearly 100%). Think of passive investors more like the water riding a wave and the active investors are the wind or gravitational force that initiate the wave and determine its energy. There is plenty of capacity for the water to serve as the medium through which the action moves.





But if Buffett sells to a passive fund at $49, he then has proportionally less than he had before, and then all the passive investors would immediately sell to mirror the buffet portfolio. In other words buffet in effect couldn't really sell to the passive investors because if he sells they have to sell too.

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Re: Larry Swedroe: New Passive Criricism Fails

Post by avalpert » Wed Sep 13, 2017 4:17 pm

JBTX wrote:
Wed Sep 13, 2017 4:12 pm
avalpert wrote:
Wed Sep 13, 2017 3:36 pm
JBTX wrote:
Wed Sep 13, 2017 3:26 pm
avalpert wrote:
Wed Sep 13, 2017 3:17 pm

No, it doesn't. It has the same affect as a trade does today - two parties set the current valuation for everyone.
But I think I am saying the same thing you are saying below in terms of price discovery. If Buffett owns security X at $50, and wants to sell it at $49, now he can probably do it. But if Soros is his only trading partner, Soros may only take it for $30. The result is Buffett sits on it until he really wants to dump it, and a huge price drop.
Except, while they may be the only two price setters they aren't the only buyers/sellers. So some fund comes in looking to by shares as close to the closing price as possible and Buffett steps up to sell at $49, another fund needs to sell shares and Soros is willing to buy at $30 - or maybe the market maker steps in and connects these passive buyer/sellers at a price in between and Buffett and Soros need to adjust their views.

Not true either - passive funds provide plenty of liquidity, just not active price discovery. Vanguard does like $2 billion in trades a day last time I saw a number.
Are the passive investors really active participants? They are just doing what everybody else is doing - apart from some new money coming into the market or leaving the market in general.
Yes, they are active participants in the sense that they actively execute lots of trading volume. Try to find one of the articles out there that goes behind the scenes into their trading floors to get a sense for what a day looks like, it is not a passive exercise.
That may be true, not because of less liquidity but because of less frequent price discovery leading to bigger jumps - but this is where the whole suspension of economics takes place in the story, if there is money to be made stepping into the void between those jumps someone will do it. And with the ample liquidity provided by passive investors, it is relatively easy for the active traders to jump in.
But there are less active investors jumping in to find the mispricings, correct?
I'm not sure there are. There may be a lower percentage of the volume being held by active investors - but that doesn't mean there are fewer active investors or even less absolute dollars behind them than say 10 years ago.
Granted, it is mostly a theoretical argument, and practically in the real world I don't know that it will make a difference, but at some point, if most of the investors are just copying what a small portion of investors are doing, that has to have an effect on the overall behavior of the market...does it not?
I'm not sure it does until true extremes (like nearly 100%). Think of passive investors more like the water riding a wave and the active investors are the wind or gravitational force that initiate the wave and determine its energy. There is plenty of capacity for the water to serve as the medium through which the action moves.





But if Buffett sells to a passive fund at $49, he then has proportionally less than he had before, and then all the passive investors would immediately sell to mirror the buffet portfolio. In other words buffet in effect couldn't really sell to the passive investors because if he sells they have to sell too.
No they wouldn't - they wouldn't have to sell anything at all on account of that transaction. The passive investors holdings would adjust in price automatically, they don't need to act because of the actions of other investors in the stock just as they don't do so today.

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Re: Larry Swedroe: New Passive Criricism Fails

Post by JBTX » Wed Sep 13, 2017 4:24 pm

avalpert wrote:
Wed Sep 13, 2017 4:17 pm
JBTX wrote:
Wed Sep 13, 2017 4:12 pm
avalpert wrote:
Wed Sep 13, 2017 3:36 pm
JBTX wrote:
Wed Sep 13, 2017 3:26 pm


But I think I am saying the same thing you are saying below in terms of price discovery. If Buffett owns security X at $50, and wants to sell it at $49, now he can probably do it. But if Soros is his only trading partner, Soros may only take it for $30. The result is Buffett sits on it until he really wants to dump it, and a huge price drop.
Except, while they may be the only two price setters they aren't the only buyers/sellers. So some fund comes in looking to by shares as close to the closing price as possible and Buffett steps up to sell at $49, another fund needs to sell shares and Soros is willing to buy at $30 - or maybe the market maker steps in and connects these passive buyer/sellers at a price in between and Buffett and Soros need to adjust their views.



Are the passive investors really active participants? They are just doing what everybody else is doing - apart from some new money coming into the market or leaving the market in general.
Yes, they are active participants in the sense that they actively execute lots of trading volume. Try to find one of the articles out there that goes behind the scenes into their trading floors to get a sense for what a day looks like, it is not a passive exercise.
But there are less active investors jumping in to find the mispricings, correct?
I'm not sure there are. There may be a lower percentage of the volume being held by active investors - but that doesn't mean there are fewer active investors or even less absolute dollars behind them than say 10 years ago.
Granted, it is mostly a theoretical argument, and practically in the real world I don't know that it will make a difference, but at some point, if most of the investors are just copying what a small portion of investors are doing, that has to have an effect on the overall behavior of the market...does it not?
I'm not sure it does until true extremes (like nearly 100%). Think of passive investors more like the water riding a wave and the active investors are the wind or gravitational force that initiate the wave and determine its energy. There is plenty of capacity for the water to serve as the medium through which the action moves.





But if Buffett sells to a passive fund at $49, he then has proportionally less than he had before, and then all the passive investors would immediately sell to mirror the buffet portfolio. In other words buffet in effect couldn't really sell to the passive investors because if he sells they have to sell too.
No they wouldn't - they wouldn't have to sell anything at all on account of that transaction. The passive investors holdings would adjust in price automatically, they don't need to act because of the actions of other investors in the stock just as they don't do so today.


But an index is market weighted. Market value consists of number of shares and price per share. If Buffett sold shares to somebody other than soros, by definition the market would have to follow.

CantPassAgain
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Re: Larry Swedroe: New Passive Criricism Fails

Post by CantPassAgain » Wed Sep 13, 2017 4:54 pm

JBTX wrote:
Wed Sep 13, 2017 4:24 pm
avalpert wrote:
Wed Sep 13, 2017 4:17 pm
JBTX wrote:
Wed Sep 13, 2017 4:12 pm
avalpert wrote:
Wed Sep 13, 2017 3:36 pm

Except, while they may be the only two price setters they aren't the only buyers/sellers. So some fund comes in looking to by shares as close to the closing price as possible and Buffett steps up to sell at $49, another fund needs to sell shares and Soros is willing to buy at $30 - or maybe the market maker steps in and connects these passive buyer/sellers at a price in between and Buffett and Soros need to adjust their views.



Yes, they are active participants in the sense that they actively execute lots of trading volume. Try to find one of the articles out there that goes behind the scenes into their trading floors to get a sense for what a day looks like, it is not a passive exercise.



But there are less active investors jumping in to find the mispricings, correct?
I'm not sure there are. There may be a lower percentage of the volume being held by active investors - but that doesn't mean there are fewer active investors or even less absolute dollars behind them than say 10 years ago.
Granted, it is mostly a theoretical argument, and practically in the real world I don't know that it will make a difference, but at some point, if most of the investors are just copying what a small portion of investors are doing, that has to have an effect on the overall behavior of the market...does it not?
I'm not sure it does until true extremes (like nearly 100%). Think of passive investors more like the water riding a wave and the active investors are the wind or gravitational force that initiate the wave and determine its energy. There is plenty of capacity for the water to serve as the medium through which the action moves.





But if Buffett sells to a passive fund at $49, he then has proportionally less than he had before, and then all the passive investors would immediately sell to mirror the buffet portfolio. In other words buffet in effect couldn't really sell to the passive investors because if he sells they have to sell too.
No they wouldn't - they wouldn't have to sell anything at all on account of that transaction. The passive investors holdings would adjust in price automatically, they don't need to act because of the actions of other investors in the stock just as they don't do so today.


But an index is market weighted. Market value consists of number of shares and price per share. If Buffett sold shares to somebody other than soros, by definition the market would have to follow.
The rest of the market would not have to sell anything because their holdings are "marked to market" automatically.

JBTX
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Re: Larry Swedroe: New Passive Criricism Fails

Post by JBTX » Wed Sep 13, 2017 4:59 pm

CantPassAgain wrote:
Wed Sep 13, 2017 4:54 pm
JBTX wrote:
Wed Sep 13, 2017 4:24 pm
avalpert wrote:
Wed Sep 13, 2017 4:17 pm
JBTX wrote:
Wed Sep 13, 2017 4:12 pm

I'm not sure there are. There may be a lower percentage of the volume being held by active investors - but that doesn't mean there are fewer active investors or even less absolute dollars behind them than say 10 years ago.


I'm not sure it does until true extremes (like nearly 100%). Think of passive investors more like the water riding a wave and the active investors are the wind or gravitational force that initiate the wave and determine its energy. There is plenty of capacity for the water to serve as the medium through which the action moves.





But if Buffett sells to a passive fund at $49, he then has proportionally less than he had before, and then all the passive investors would immediately sell to mirror the buffet portfolio. In other words buffet in effect couldn't really sell to the passive investors because if he sells they have to sell too.
No they wouldn't - they wouldn't have to sell anything at all on account of that transaction. The passive investors holdings would adjust in price automatically, they don't need to act because of the actions of other investors in the stock just as they don't do so today.


But an index is market weighted. Market value consists of number of shares and price per share. If Buffett sold shares to somebody other than soros, by definition the market would have to follow.
The rest of the market would not have to sell anything because their holdings are "marked to market" automatically.
The price is, but not the number of shares. Market consists of price and share volume.

CantPassAgain
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Re: Larry Swedroe: New Passive Criricism Fails

Post by CantPassAgain » Wed Sep 13, 2017 5:02 pm

JBTX wrote:
Wed Sep 13, 2017 4:59 pm
CantPassAgain wrote:
Wed Sep 13, 2017 4:54 pm
JBTX wrote:
Wed Sep 13, 2017 4:24 pm
avalpert wrote:
Wed Sep 13, 2017 4:17 pm
JBTX wrote:
Wed Sep 13, 2017 4:12 pm







But if Buffett sells to a passive fund at $49, he then has proportionally less than he had before, and then all the passive investors would immediately sell to mirror the buffet portfolio. In other words buffet in effect couldn't really sell to the passive investors because if he sells they have to sell too.
No they wouldn't - they wouldn't have to sell anything at all on account of that transaction. The passive investors holdings would adjust in price automatically, they don't need to act because of the actions of other investors in the stock just as they don't do so today.


But an index is market weighted. Market value consists of number of shares and price per share. If Buffett sold shares to somebody other than soros, by definition the market would have to follow.
The rest of the market would not have to sell anything because their holdings are "marked to market" automatically.
The price is, but not the number of shares. Market consists of price and share volume.
I guess you lost me. I don't see where any shares were created or destroyed in this scenario.

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Re: Larry Swedroe: New Passive Criticism Fails

Post by bottlecap » Wed Sep 13, 2017 5:11 pm

It's interesting that the data contradicts the argument.

However, I agree with nedsaid as to this being a long way off. In addition, I believe the "problem" will never arise unless someone tries to "fix" it.

This is a self-correcting "problem." If it ever gets to the point where indexing creates market inefficiencies that can be exploited, more people will stop indexing to exploit them. They will begin doing this before anyone else notices any "problem."

The only way that the problem will stop being self-correcting is if the government steps in and singles out index investing to tell people what they can and can't do, as some anti-indexers have argued, to prevent the "problem" which doesn't yet exist. Otherwise, market choice with respect to investing fixes this supposed "problem" before anyone notices.

JT

JBTX
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Re: Larry Swedroe: New Passive Criricism Fails

Post by JBTX » Wed Sep 13, 2017 5:38 pm

CantPassAgain wrote:
Wed Sep 13, 2017 5:02 pm
JBTX wrote:
Wed Sep 13, 2017 4:59 pm
CantPassAgain wrote:
Wed Sep 13, 2017 4:54 pm
JBTX wrote:
Wed Sep 13, 2017 4:24 pm
avalpert wrote:
Wed Sep 13, 2017 4:17 pm

No they wouldn't - they wouldn't have to sell anything at all on account of that transaction. The passive investors holdings would adjust in price automatically, they don't need to act because of the actions of other investors in the stock just as they don't do so today.


But an index is market weighted. Market value consists of number of shares and price per share. If Buffett sold shares to somebody other than soros, by definition the market would have to follow.
The rest of the market would not have to sell anything because their holdings are "marked to market" automatically.
The price is, but not the number of shares. Market consists of price and share volume.
I guess you lost me. I don't see where any shares were created or destroyed in this scenario.
You have two markets:

Active = Buffet + Soros
Passive = everything else

Passive is based upon market cap. market cap is share price times number of shares. Passive ownership proportion by definition = active ownership proportion.

If Buffett wants to sell all of his holdings of Stock X, and for some reason Soros absolutely doesn't want it (nor owns it already), then the passive market by definition CANNOT buy it. The passive market is a reflection of active. It can't have shares that neither Buffett or Soros have. If the passive market bought it, then it would have to immediately sell it, and there would be nobody to sell it to, then the passive index blows up because it is no longer reflecting the market.

The net effect is Buffett and Soros can really only buy and sell to each other.

JBTX
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Re: Larry Swedroe: New Passive Criticism Fails

Post by JBTX » Wed Sep 13, 2017 5:48 pm

Not sure why people are arguing this. Even Bogle admits it.

http://www.marketwatch.com/story/john-b ... 2017-06-01

John Bogle, the founder of the Vanguard Group and the person who ignited the trend toward index investing four decades ago, acknowledged recently that this circle could turn vicious eventually and cause downright tragic events in the stock market.

“If everybody indexed, the only word you could use is chaos, catastrophe,” Bogle told Yahoo Finance at the Berkshire Hathaway annual meeting last month. “The markets would fail,” he added.

Bogle noted that trading would dry up if the stock market comprised only indexers and there were no active investors setting prices on individual issues. Everyone would just buy or sell the market.

Read: John Bogle explains why index investors shouldn’t fear a stock downturn

The market is not entirely owned by indexers, of course, and it never will be, and Bogle pointed out that as indexing increases to a certain point, it opens opportunities for active investors to exploit inefficiencies in the pricing of some stocks. But past that point, wherever it might be — somewhere beyond 75%, in his view — the market could become a dangerous place.

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Re: Larry Swedroe: New Passive Criricism Fails

Post by incognito_man » Wed Sep 13, 2017 6:12 pm

NateH wrote:
Wed Sep 13, 2017 11:32 am
If any of these criticisms start to actually work, they will be quietly arbitraged out :moneybag before anyone gets to write articles and give testimony to regulators. My feeling is it wouldn't take very many active participants to keep pricing efficient, considering their motivation is to make money.
This was my thought as well. The moment we stop hearing from active investors that passive investing is negatively impacting/distorting markets is probably exactly the time we should all consider looking into active management :happy

As long as 'they' are publicly bellyaching, remaining in passive funds is sure to be the best bet.

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Re: Larry Swedroe: New Passive Criricism Fails

Post by CantPassAgain » Wed Sep 13, 2017 6:16 pm

JBTX wrote:
Wed Sep 13, 2017 5:38 pm
CantPassAgain wrote:
Wed Sep 13, 2017 5:02 pm
JBTX wrote:
Wed Sep 13, 2017 4:59 pm
CantPassAgain wrote:
Wed Sep 13, 2017 4:54 pm
JBTX wrote:
Wed Sep 13, 2017 4:24 pm




But an index is market weighted. Market value consists of number of shares and price per share. If Buffett sold shares to somebody other than soros, by definition the market would have to follow.
The rest of the market would not have to sell anything because their holdings are "marked to market" automatically.
The price is, but not the number of shares. Market consists of price and share volume.
I guess you lost me. I don't see where any shares were created or destroyed in this scenario.
You have two markets:

Active = Buffet + Soros
Passive = everything else

Passive is based upon market cap. market cap is share price times number of shares. Passive ownership proportion by definition = active ownership proportion.

If Buffett wants to sell all of his holdings of Stock X, and for some reason Soros absolutely doesn't want it (nor owns it already), then the passive market by definition CANNOT buy it. The passive market is a reflection of active. It can't have shares that neither Buffett or Soros have. If the passive market bought it, then it would have to immediately sell it, and there would be nobody to sell it to, then the passive index blows up because it is no longer reflecting the market.

The net effect is Buffett and Soros can really only buy and sell to each other.
I dunno about all that but it seems to me that Buffet is going to have to:

1) Hold, in which case nothing happens
2) Reduce his price so that, even if Soros doesn't want it, someone from the passive gang is so enticed they abandon their passive strategy and buy from Buffet.

Now we have three active market players as a result of indexing becoming too prevalent.

JBTX
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Re: Larry Swedroe: New Passive Criricism Fails

Post by JBTX » Wed Sep 13, 2017 6:25 pm

CantPassAgain wrote:
Wed Sep 13, 2017 6:16 pm
JBTX wrote:
Wed Sep 13, 2017 5:38 pm
CantPassAgain wrote:
Wed Sep 13, 2017 5:02 pm
JBTX wrote:
Wed Sep 13, 2017 4:59 pm
CantPassAgain wrote:
Wed Sep 13, 2017 4:54 pm


The rest of the market would not have to sell anything because their holdings are "marked to market" automatically.
The price is, but not the number of shares. Market consists of price and share volume.
I guess you lost me. I don't see where any shares were created or destroyed in this scenario.
You have two markets:

Active = Buffet + Soros
Passive = everything else

Passive is based upon market cap. market cap is share price times number of shares. Passive ownership proportion by definition = active ownership proportion.

If Buffett wants to sell all of his holdings of Stock X, and for some reason Soros absolutely doesn't want it (nor owns it already), then the passive market by definition CANNOT buy it. The passive market is a reflection of active. It can't have shares that neither Buffett or Soros have. If the passive market bought it, then it would have to immediately sell it, and there would be nobody to sell it to, then the passive index blows up because it is no longer reflecting the market.

The net effect is Buffett and Soros can really only buy and sell to each other.
I dunno about all that but it seems to me that Buffet is going to have to:

1) Hold, in which case nothing happens
2) Reduce his price so that, even if Soros doesn't want it, someone from the passive gang is so enticed they abandon their passive strategy and buy from Buffet.

Now we have three active market players as a result of indexing becoming too prevalent.
You are slowly getting there. :beer

Its kind of a circular reference situation. The answer is the price of the stock Buffett is selling will instantaneously falls to zero and will become worthless.

Admittedly, it is a purely theoretical exercise, but I think it is illustrative of the distortions, on an EXTREME scale, of the types of problems you start to approach when the active market shrinks vs the size of a passive market.

CantPassAgain
Posts: 419
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Re: Larry Swedroe: New Passive Criricism Fails

Post by CantPassAgain » Wed Sep 13, 2017 6:36 pm

JBTX wrote:
Wed Sep 13, 2017 6:25 pm
CantPassAgain wrote:
Wed Sep 13, 2017 6:16 pm
JBTX wrote:
Wed Sep 13, 2017 5:38 pm
CantPassAgain wrote:
Wed Sep 13, 2017 5:02 pm
JBTX wrote:
Wed Sep 13, 2017 4:59 pm


The price is, but not the number of shares. Market consists of price and share volume.
I guess you lost me. I don't see where any shares were created or destroyed in this scenario.
You have two markets:

Active = Buffet + Soros
Passive = everything else

Passive is based upon market cap. market cap is share price times number of shares. Passive ownership proportion by definition = active ownership proportion.

If Buffett wants to sell all of his holdings of Stock X, and for some reason Soros absolutely doesn't want it (nor owns it already), then the passive market by definition CANNOT buy it. The passive market is a reflection of active. It can't have shares that neither Buffett or Soros have. If the passive market bought it, then it would have to immediately sell it, and there would be nobody to sell it to, then the passive index blows up because it is no longer reflecting the market.

The net effect is Buffett and Soros can really only buy and sell to each other.
I dunno about all that but it seems to me that Buffet is going to have to:

1) Hold, in which case nothing happens
2) Reduce his price so that, even if Soros doesn't want it, someone from the passive gang is so enticed they abandon their passive strategy and buy from Buffet.

Now we have three active market players as a result of indexing becoming too prevalent.
You are slowly getting there. :beer

Its kind of a circular reference situation. The answer is the price of the stock Buffett is selling will instantaneously falls to zero and will become worthless.

Admittedly, it is a purely theoretical exercise, but I think it is illustrative of the distortions, on an EXTREME scale, of the types of problems you start to approach when the active market shrinks vs the size of a passive market.
I don't see it as a problem at all. I thought my example was was a pretty simple and elegant way of illustrating the self-correcting nature of markets.

JBTX
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Re: Larry Swedroe: New Passive Criricism Fails

Post by JBTX » Wed Sep 13, 2017 6:45 pm

CantPassAgain wrote:
Wed Sep 13, 2017 6:36 pm
JBTX wrote:
Wed Sep 13, 2017 6:25 pm
CantPassAgain wrote:
Wed Sep 13, 2017 6:16 pm
JBTX wrote:
Wed Sep 13, 2017 5:38 pm
CantPassAgain wrote:
Wed Sep 13, 2017 5:02 pm


I guess you lost me. I don't see where any shares were created or destroyed in this scenario.
You have two markets:

Active = Buffet + Soros
Passive = everything else

Passive is based upon market cap. market cap is share price times number of shares. Passive ownership proportion by definition = active ownership proportion.

If Buffett wants to sell all of his holdings of Stock X, and for some reason Soros absolutely doesn't want it (nor owns it already), then the passive market by definition CANNOT buy it. The passive market is a reflection of active. It can't have shares that neither Buffett or Soros have. If the passive market bought it, then it would have to immediately sell it, and there would be nobody to sell it to, then the passive index blows up because it is no longer reflecting the market.

The net effect is Buffett and Soros can really only buy and sell to each other.
I dunno about all that but it seems to me that Buffet is going to have to:

1) Hold, in which case nothing happens
2) Reduce his price so that, even if Soros doesn't want it, someone from the passive gang is so enticed they abandon their passive strategy and buy from Buffet.

Now we have three active market players as a result of indexing becoming too prevalent.
You are slowly getting there. :beer

Its kind of a circular reference situation. The answer is the price of the stock Buffett is selling will instantaneously falls to zero and will become worthless.

Admittedly, it is a purely theoretical exercise, but I think it is illustrative of the distortions, on an EXTREME scale, of the types of problems you start to approach when the active market shrinks vs the size of a passive market.
I don't see it as a problem at all. I thought my example was was a pretty simple and elegant way of illustrating the self-correcting nature of markets.
So in other words you think Bogle is wrong in his assessment?

incognito_man
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Location: Madison, WI

Re: Larry Swedroe: New Passive Criricism Fails

Post by incognito_man » Wed Sep 13, 2017 6:51 pm

CantPassAgain wrote:
Wed Sep 13, 2017 6:36 pm
JBTX wrote:
Wed Sep 13, 2017 6:25 pm
CantPassAgain wrote:
Wed Sep 13, 2017 6:16 pm
JBTX wrote:
Wed Sep 13, 2017 5:38 pm
CantPassAgain wrote:
Wed Sep 13, 2017 5:02 pm


I guess you lost me. I don't see where any shares were created or destroyed in this scenario.
You have two markets:

Active = Buffet + Soros
Passive = everything else

Passive is based upon market cap. market cap is share price times number of shares. Passive ownership proportion by definition = active ownership proportion.

If Buffett wants to sell all of his holdings of Stock X, and for some reason Soros absolutely doesn't want it (nor owns it already), then the passive market by definition CANNOT buy it. The passive market is a reflection of active. It can't have shares that neither Buffett or Soros have. If the passive market bought it, then it would have to immediately sell it, and there would be nobody to sell it to, then the passive index blows up because it is no longer reflecting the market.

The net effect is Buffett and Soros can really only buy and sell to each other.
I dunno about all that but it seems to me that Buffet is going to have to:

1) Hold, in which case nothing happens
2) Reduce his price so that, even if Soros doesn't want it, someone from the passive gang is so enticed they abandon their passive strategy and buy from Buffet.

Now we have three active market players as a result of indexing becoming too prevalent.
You are slowly getting there. :beer

Its kind of a circular reference situation. The answer is the price of the stock Buffett is selling will instantaneously falls to zero and will become worthless.

Admittedly, it is a purely theoretical exercise, but I think it is illustrative of the distortions, on an EXTREME scale, of the types of problems you start to approach when the active market shrinks vs the size of a passive market.
I don't see it as a problem at all. I thought my example was was a pretty simple and elegant way of illustrating the self-correcting nature of markets.
The alternative is, the stock is actually worthless and deserves to be removed from the market :happy

CantPassAgain
Posts: 419
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Re: Larry Swedroe: New Passive Criricism Fails

Post by CantPassAgain » Wed Sep 13, 2017 6:54 pm

JBTX wrote:
Wed Sep 13, 2017 6:45 pm
So in other words you think Bogle is wrong in his assessment?
Here is the key statement:
The market is not entirely owned by indexers, of course, and it never will be, and Bogle pointed out that as indexing increases to a certain point, it opens opportunities for active investors to exploit inefficiencies in the pricing of some stocks. But past that point, wherever it might be — somewhere beyond 75%, in his view — the market could become a dangerous place.
Top
"Bogle pointed out that as indexing increases to a certain point, it opens opportunities for active investors to exploit inefficiencies in the pricing of some stocks."

Ok, so if those opportunities exist do you believe that active managers won't actually exploit these mispricings? Because that's the only way the rest of the statement "But past that point, wherever it might be — somewhere beyond 75%, in his view — the market could become a dangerous place" would ever occur.

avalpert
Posts: 5683
Joined: Sat Mar 22, 2008 4:58 pm

Re: Larry Swedroe: New Passive Criricism Fails

Post by avalpert » Wed Sep 13, 2017 7:09 pm

JBTX wrote:
Wed Sep 13, 2017 5:38 pm
CantPassAgain wrote:
Wed Sep 13, 2017 5:02 pm
JBTX wrote:
Wed Sep 13, 2017 4:59 pm
CantPassAgain wrote:
Wed Sep 13, 2017 4:54 pm
JBTX wrote:
Wed Sep 13, 2017 4:24 pm




But an index is market weighted. Market value consists of number of shares and price per share. If Buffett sold shares to somebody other than soros, by definition the market would have to follow.
The rest of the market would not have to sell anything because their holdings are "marked to market" automatically.
The price is, but not the number of shares. Market consists of price and share volume.
I guess you lost me. I don't see where any shares were created or destroyed in this scenario.
You have two markets:

Active = Buffet + Soros
Passive = everything else
No, this is completely wrong, there is just one market. Passive funds do not care whether other share owners are passive or active investors - they care only about shares outstanding (there are some difference on the margin of how you define that but none of it has to do with active or passive).
Buffet could sell all his shares to a passive fund - it has zero effect on shares outstanding and zero effect on what other passive funds have to do.

I'm not sure where you misunderstanding comes from, but it is fundamental. Do you think passive funds today go around trying to figure out what percentage of shares of a given stock are held by other passive funds?
If Buffett wants to sell all of his holdings of Stock X, and for some reason Soros absolutely doesn't want it (nor owns it already), then the passive market by definition CANNOT buy it.
Of course they could, and if they were net buyers that day (and some fund inevitably would be) they would.
The passive market is a reflection of active. It can't have shares that neither Buffett or Soros have.
This makes no sense, they only own shares that neither Buffett or Soros own. You realize they own actual shares right, and that no active investor will own them too.

jalbert
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Re: Larry Swedroe: New Passive Criticism Fails

Post by jalbert » Wed Sep 13, 2017 7:15 pm

Gosh, why should a muppet ever invest in an index fund when he or she can take advantage of pricing inefficiencies to fleece the big investment banks and hedge funds?
Risk is not a guarantor of return.

JBTX
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Re: Larry Swedroe: New Passive Criricism Fails

Post by JBTX » Wed Sep 13, 2017 7:16 pm

CantPassAgain wrote:
Wed Sep 13, 2017 6:54 pm
JBTX wrote:
Wed Sep 13, 2017 6:45 pm
So in other words you think Bogle is wrong in his assessment?
Here is the key statement:
The market is not entirely owned by indexers, of course, and it never will be, and Bogle pointed out that as indexing increases to a certain point, it opens opportunities for active investors to exploit inefficiencies in the pricing of some stocks. But past that point, wherever it might be — somewhere beyond 75%, in his view — the market could become a dangerous place.
Top
"Bogle pointed out that as indexing increases to a certain point, it opens opportunities for active investors to exploit inefficiencies in the pricing of some stocks."

Ok, so if those opportunities exist do you believe that active managers won't actually exploit these mispricings? Because that's the only way the rest of the statement "But past that point, wherever it might be — somewhere beyond 75%, in his view — the market could become a dangerous place" would ever occur.
Actually his view on the subject is more dire than mine. I've only asserted that passive investing will change the dynamics of the market, along with many other things that already have. He is saying at some point it could actually be dangerous.

Seems to me at this point you have a greater argument with Bogle than with me.

CantPassAgain
Posts: 419
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Re: Larry Swedroe: New Passive Criricism Fails

Post by CantPassAgain » Wed Sep 13, 2017 7:23 pm

JBTX wrote:
Wed Sep 13, 2017 7:16 pm
Actually his view on the subject is more dire than mine. I've only asserted that passive investing will change the dynamics of the market, along with many other things that already have. He is saying at some point it could actually be dangerous.

Seems to me at this point you have a greater argument with Bogle than with me.
I have no problem with Bogle. I just wanted to speak to your incorrect assertion that passive funds have to buy and sell based on what active traders are doing. It's just not true and not the way cap weighted indexing works.

JBTX
Posts: 933
Joined: Wed Jul 26, 2017 12:46 pm

Re: Larry Swedroe: New Passive Criricism Fails

Post by JBTX » Wed Sep 13, 2017 7:31 pm

avalpert wrote:
Wed Sep 13, 2017 7:09 pm
JBTX wrote:
Wed Sep 13, 2017 5:38 pm
CantPassAgain wrote:
Wed Sep 13, 2017 5:02 pm
JBTX wrote:
Wed Sep 13, 2017 4:59 pm
CantPassAgain wrote:
Wed Sep 13, 2017 4:54 pm


The rest of the market would not have to sell anything because their holdings are "marked to market" automatically.
The price is, but not the number of shares. Market consists of price and share volume.
I guess you lost me. I don't see where any shares were created or destroyed in this scenario.
You have two markets:

Active = Buffet + Soros
Passive = everything else
No, this is completely wrong, there is just one market. Passive funds do not care whether other share owners are passive or active investors - they care only about shares outstanding (there are some difference on the margin of how you define that but none of it has to do with active or passive).
Buffet could sell all his shares to a passive fund - it has zero effect on shares outstanding and zero effect on what other passive funds have to do.
Paraphrasing Buffett:
Buffett's main reasoning in favor of index fund investing, and for S&P 500 index funds in particular, is that by definition, they will match the market's performance over time -- no more, no less. And with rock-bottom management expenses, investors will be the beneficiary of virtually all of the gains -- not investment managers.
https://www.fool.com/investing/2017/06/ ... funds.aspx


I'm not sure where you misunderstanding comes from, but it is fundamental. Do you think passive funds today go around trying to figure out what percentage of shares of a given stock are held by other passive funds?
Apparently Buffett has a fundamental misuderstanding too.

If Buffett wants to sell all of his holdings of Stock X, and for some reason Soros absolutely doesn't want it (nor owns it already), then the passive market by definition CANNOT buy it.
Of course they could, and if they were net buyers that day (and some fund inevitably would be) they would.
The passive market is a reflection of active. It can't have shares that neither Buffett or Soros have.
This makes no sense, they only own shares that neither Buffett or Soros own. You realize they own actual shares right, and that no active investor will own them too.
Passive funds are index funds. Let's take the total stock market index. It is weighted by the market capitalization of all the companies it encompasses.

Passive funds effectively mirror the active market. Yes, they mirror the entire market, including other passive funds, but at the end of the day passive funds pursue the same benchmark market cap weightings, which are determined by active markets (see Buffett above).

I don't think you either understood or even read my hypothetical.

May here are so married to the blind ideology of index funds that now they are arguing with their chief proponents, Bogle and Buffett. :oops:

avalpert
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Re: Larry Swedroe: New Passive Criricism Fails

Post by avalpert » Wed Sep 13, 2017 7:35 pm

JBTX wrote:
Wed Sep 13, 2017 7:16 pm
CantPassAgain wrote:
Wed Sep 13, 2017 6:54 pm
JBTX wrote:
Wed Sep 13, 2017 6:45 pm
So in other words you think Bogle is wrong in his assessment?
Here is the key statement:
The market is not entirely owned by indexers, of course, and it never will be, and Bogle pointed out that as indexing increases to a certain point, it opens opportunities for active investors to exploit inefficiencies in the pricing of some stocks. But past that point, wherever it might be — somewhere beyond 75%, in his view — the market could become a dangerous place.
Top
"Bogle pointed out that as indexing increases to a certain point, it opens opportunities for active investors to exploit inefficiencies in the pricing of some stocks."

Ok, so if those opportunities exist do you believe that active managers won't actually exploit these mispricings? Because that's the only way the rest of the statement "But past that point, wherever it might be — somewhere beyond 75%, in his view — the market could become a dangerous place" would ever occur.
Actually his view on the subject is more dire than mine. I've only asserted that passive investing will change the dynamics of the market, along with many other things that already have. He is saying at some point it could actually be dangerous.

Seems to me at this point you have a greater argument with Bogle than with me.
This is ridiculous - not only are you arguing from authority (a logical fallacy) but you are mischarectirizing the authority, badly.

What he actually said was if everybody indexed it would be chaotic and the chances of that happening are [b[zero[/b]. He said it could exceed 75% of the market and not be dangerous.

JBTX
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Re: Larry Swedroe: New Passive Criricism Fails

Post by JBTX » Wed Sep 13, 2017 7:36 pm

CantPassAgain wrote:
Wed Sep 13, 2017 7:23 pm
JBTX wrote:
Wed Sep 13, 2017 7:16 pm
Actually his view on the subject is more dire than mine. I've only asserted that passive investing will change the dynamics of the market, along with many other things that already have. He is saying at some point it could actually be dangerous.

Seems to me at this point you have a greater argument with Bogle than with me.
I have no problem with Bogle. I just wanted to speak to your incorrect assertion that passive funds have to buy and sell based on what active traders are doing. It's just not true and not the way cap weighted indexing works.

Of course they do. Indexes reflect market capitalization weighting of the market.

Again, Buffett:
Buffett's main reasoning in favor of index fund investing, and for S&P 500 index funds in particular, is that by definition, they will match the market's performance over time -- no more, no less. And with rock-bottom management expenses, investors will be the beneficiary of virtually all of the gains -- not investment managers.
The only way the match performance, by definition, is they hold proportionately exactly the same thing as the sum total of the active market.

CantPassAgain
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Re: Larry Swedroe: New Passive Criricism Fails

Post by CantPassAgain » Wed Sep 13, 2017 7:37 pm

JBTX wrote:
Wed Sep 13, 2017 7:31 pm
Passive funds are index funds. Let's take the total stock market index. It is weighted by the market capitalization of all the companies it encompasses.

Passive funds effectively mirror the active market. Yes, they mirror the entire market, including other passive funds, but at the end of the day passive funds pursue the same benchmark market cap weightings, which are determined by active markets (see Buffett above).

I don't think you either understood or even read my hypothetical.

May here are so married to the blind ideology of index funds that now they are arguing with their chief proponents, Bogle and Buffett. :oops:
Sheesh, people are just trying to point out incorrect statements. You said that passive funds have to trade based on what active traders are doing. This is simply not true with cap weighted indexes.

Now there were some attempts at creating index funds in the 70's that used an equal weighted approach. I think maybe it was IBM pension fund? Too lazy to look it up, but it was reportedly a disaster because of all the trading that had to be done. It was just unworkable. Letting the weights float with the market cap solves that problem.
Last edited by CantPassAgain on Wed Sep 13, 2017 7:39 pm, edited 3 times in total.

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Re: Larry Swedroe: New Passive Criricism Fails

Post by JBTX » Wed Sep 13, 2017 7:38 pm

avalpert wrote:
Wed Sep 13, 2017 7:35 pm
JBTX wrote:
Wed Sep 13, 2017 7:16 pm
CantPassAgain wrote:
Wed Sep 13, 2017 6:54 pm
JBTX wrote:
Wed Sep 13, 2017 6:45 pm
So in other words you think Bogle is wrong in his assessment?
Here is the key statement:
The market is not entirely owned by indexers, of course, and it never will be, and Bogle pointed out that as indexing increases to a certain point, it opens opportunities for active investors to exploit inefficiencies in the pricing of some stocks. But past that point, wherever it might be — somewhere beyond 75%, in his view — the market could become a dangerous place.
Top
"Bogle pointed out that as indexing increases to a certain point, it opens opportunities for active investors to exploit inefficiencies in the pricing of some stocks."

Ok, so if those opportunities exist do you believe that active managers won't actually exploit these mispricings? Because that's the only way the rest of the statement "But past that point, wherever it might be — somewhere beyond 75%, in his view — the market could become a dangerous place" would ever occur.
Actually his view on the subject is more dire than mine. I've only asserted that passive investing will change the dynamics of the market, along with many other things that already have. He is saying at some point it could actually be dangerous.

Seems to me at this point you have a greater argument with Bogle than with me.
This is ridiculous - not only are you arguing from authority (a logical fallacy) but you are mischarectirizing the authority, badly.

What he actually said was if everybody indexed it would be chaotic and the chances of that happening are [b[zero[/b]. He said it could exceed 75% of the market and not be dangerous.
He said over 75% could be dangerous.

I never personally used the word dangerous.

JBTX
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Joined: Wed Jul 26, 2017 12:46 pm

Re: Larry Swedroe: New Passive Criricism Fails

Post by JBTX » Wed Sep 13, 2017 7:40 pm

CantPassAgain wrote:
Wed Sep 13, 2017 7:37 pm
JBTX wrote:
Wed Sep 13, 2017 7:31 pm
Passive funds are index funds. Let's take the total stock market index. It is weighted by the market capitalization of all the companies it encompasses.

Passive funds effectively mirror the active market. Yes, they mirror the entire market, including other passive funds, but at the end of the day passive funds pursue the same benchmark market cap weightings, which are determined by active markets (see Buffett above).

I don't think you either understood or even read my hypothetical.

May here are so married to the blind ideology of index funds that now they are arguing with their chief proponents, Bogle and Buffett. :oops:
Sheesh, people are just trying to point out incorrect statements. You said that passive funds have to trade based on what active traders are doing. This is simply not true with cap weighted indexes.

Now there were some attempts at creating index funds in the 70's that used an equal weighted approach. I think maybe it was IBM pension fund? Too lazy to look it up, but it was reportedly a disaster because of all the trading that had to be done. It was just unworkable. Just letting the market cap float with the market solves that problem.

The index funds mirror the holdings of active markets. By definition. Who said anything about equal weighted indexes? I didn't. I am talking about market weighted indexes, like S&P 500 or total market index.

avalpert
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Re: Larry Swedroe: New Passive Criricism Fails

Post by avalpert » Wed Sep 13, 2017 7:41 pm

JBTX wrote:
Wed Sep 13, 2017 7:31 pm
avalpert wrote:
Wed Sep 13, 2017 7:09 pm
JBTX wrote:
Wed Sep 13, 2017 5:38 pm
CantPassAgain wrote:
Wed Sep 13, 2017 5:02 pm
JBTX wrote:
Wed Sep 13, 2017 4:59 pm


The price is, but not the number of shares. Market consists of price and share volume.
I guess you lost me. I don't see where any shares were created or destroyed in this scenario.
You have two markets:

Active = Buffet + Soros
Passive = everything else
No, this is completely wrong, there is just one market. Passive funds do not care whether other share owners are passive or active investors - they care only about shares outstanding (there are some difference on the margin of how you define that but none of it has to do with active or passive).
Buffet could sell all his shares to a passive fund - it has zero effect on shares outstanding and zero effect on what other passive funds have to do.
Paraphrasing Buffett:
Buffett's main reasoning in favor of index fund investing, and for S&P 500 index funds in particular, is that by definition, they will match the market's performance over time -- no more, no less. And with rock-bottom management expenses, investors will be the beneficiary of virtually all of the gains -- not investment managers.
https://www.fool.com/investing/2017/06/ ... funds.aspx
Why do you think that is responsive to my post above? I am trying to understand where your misunderstanding comes from - nothing in this statement addresses what we were discussing.
If Buffett wants to sell all of his holdings of Stock X, and for some reason Soros absolutely doesn't want it (nor owns it already), then the passive market by definition CANNOT buy it.
Of course they could, and if they were net buyers that day (and some fund inevitably would be) they would.
The passive market is a reflection of active. It can't have shares that neither Buffett or Soros have.
This makes no sense, they only own shares that neither Buffett or Soros own. You realize they own actual shares right, and that no active investor will own them too.
Passive funds are index funds. Let's take the total stock market index. It is weighted by the market capitalization of all the companies it encompasses.

Passive funds effectively mirror the active market. Yes, they mirror the entire market, including other passive funds, but at the end of the day passive funds pursue the same benchmark market cap weightings, which are determined by active markets (see Buffett above).

I don't think you either understood or even read my hypothetical.
You are making a complete non-sequitur. I read and understood your hypothetical - you get the mechanics of index funds wrong. The market cap is a function of price and shares outstanding, the price used automatically adjusts with the last sale and shares outstanding don't change regardless of whether the parties trading are active or passive - index funds need take no action in result to the Buffett of your example selling all his shares to a passive fund.
May here are so married to the blind ideology of index funds that now they are arguing with their chief proponents, Bogle and Buffett. :oops:
Dude, you are fundamentally wrong about how passive indexes work. This isn't about blind ideology (if it is it would be yours but I don't get the sense that your error is driven by ideology), you are just mistaken.

avalpert
Posts: 5683
Joined: Sat Mar 22, 2008 4:58 pm

Re: Larry Swedroe: New Passive Criricism Fails

Post by avalpert » Wed Sep 13, 2017 7:42 pm

JBTX wrote:
Wed Sep 13, 2017 7:38 pm
avalpert wrote:
Wed Sep 13, 2017 7:35 pm
JBTX wrote:
Wed Sep 13, 2017 7:16 pm
CantPassAgain wrote:
Wed Sep 13, 2017 6:54 pm
JBTX wrote:
Wed Sep 13, 2017 6:45 pm
So in other words you think Bogle is wrong in his assessment?
Here is the key statement:
The market is not entirely owned by indexers, of course, and it never will be, and Bogle pointed out that as indexing increases to a certain point, it opens opportunities for active investors to exploit inefficiencies in the pricing of some stocks. But past that point, wherever it might be — somewhere beyond 75%, in his view — the market could become a dangerous place.
Top
"Bogle pointed out that as indexing increases to a certain point, it opens opportunities for active investors to exploit inefficiencies in the pricing of some stocks."

Ok, so if those opportunities exist do you believe that active managers won't actually exploit these mispricings? Because that's the only way the rest of the statement "But past that point, wherever it might be — somewhere beyond 75%, in his view — the market could become a dangerous place" would ever occur.
Actually his view on the subject is more dire than mine. I've only asserted that passive investing will change the dynamics of the market, along with many other things that already have. He is saying at some point it could actually be dangerous.

Seems to me at this point you have a greater argument with Bogle than with me.
This is ridiculous - not only are you arguing from authority (a logical fallacy) but you are mischarectirizing the authority, badly.

What he actually said was if everybody indexed it would be chaotic and the chances of that happening are zero. He said it could exceed 75% of the market and not be dangerous.
He said over 75% could be dangerous.
No, he didn't. You might want to go back to the original source here.
Last edited by avalpert on Wed Sep 13, 2017 7:46 pm, edited 1 time in total.

avalpert
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Re: Larry Swedroe: New Passive Criricism Fails

Post by avalpert » Wed Sep 13, 2017 7:44 pm

JBTX wrote:
Wed Sep 13, 2017 7:36 pm

The only way the match performance, by definition, is they hold proportionately exactly the same thing as the sum total of the active market.
Again, this is incorrect. Any given index funds needs to hold (in an idealized sense, at the margins they won't do it perfectly) each component of the index in the same proportions to their outstanding shares - there is no reference point to the active market at all that they need to keep to, they are indifferent to whether other holders of shares are active or passive holders (if they could even figure it out).

JBTX
Posts: 933
Joined: Wed Jul 26, 2017 12:46 pm

Re: Larry Swedroe: New Passive Criricism Fails

Post by JBTX » Wed Sep 13, 2017 7:53 pm

avalpert wrote:
Wed Sep 13, 2017 7:42 pm
JBTX wrote:
Wed Sep 13, 2017 7:38 pm
avalpert wrote:
Wed Sep 13, 2017 7:35 pm
JBTX wrote:
Wed Sep 13, 2017 7:16 pm
CantPassAgain wrote:
Wed Sep 13, 2017 6:54 pm


Here is the key statement:



"Bogle pointed out that as indexing increases to a certain point, it opens opportunities for active investors to exploit inefficiencies in the pricing of some stocks."

Ok, so if those opportunities exist do you believe that active managers won't actually exploit these mispricings? Because that's the only way the rest of the statement "But past that point, wherever it might be — somewhere beyond 75%, in his view — the market could become a dangerous place" would ever occur.
Actually his view on the subject is more dire than mine. I've only asserted that passive investing will change the dynamics of the market, along with many other things that already have. He is saying at some point it could actually be dangerous.

Seems to me at this point you have a greater argument with Bogle than with me.
This is ridiculous - not only are you arguing from authority (a logical fallacy) but you are mischarectirizing the authority, badly.

What he actually said was if everybody indexed it would be chaotic and the chances of that happening are zero. He said it could exceed 75% of the market and not be dangerous.
He said over 75% could be dangerous.
No, he didn't. You might want to go back to the original source here.
Fair enough. I only quoted a source related to the wall street journal. I didn't know they misquoted it.

https://finance.yahoo.com/news/jack-bog ... 10197.html

Having said that, I don't have any argument with anything he said in the interview.

As I read the article, I think he is acknowledging there is a theoretical issue if mostly people index, but practically he thinks it will work its way out. Which is exactly what I have been saying. All I have ever said is that it may change the behavior of the market somewhat, just like program trading and other things.

avalpert
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Joined: Sat Mar 22, 2008 4:58 pm

Re: Larry Swedroe: New Passive Criricism Fails

Post by avalpert » Wed Sep 13, 2017 8:05 pm

JBTX wrote:
Wed Sep 13, 2017 7:53 pm
As I read the article, I think he is acknowledging there is a theoretical issue if mostly people index, but practically he thinks it will work its way out. Which is exactly what I have been saying.
He is saying if everybody indexed it would be chaotic and that it is not only practically unlikely it is impossible (he literally says the chance is zero). It is kind of like acknowledging that if people were suddenly unable to do math the stock market would be paralyzed.
JBTX wrote:
Wed Sep 13, 2017 7:53 pm
All I have ever said is that it may change the behavior of the market somewhat, just like program trading and other things.
You also described a very specific mechanism for how passive funds would act based on active traders leaving the market that was incorrect.

JBTX
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Joined: Wed Jul 26, 2017 12:46 pm

Re: Larry Swedroe: New Passive Criricism Fails

Post by JBTX » Wed Sep 13, 2017 8:10 pm

avalpert wrote:
Wed Sep 13, 2017 7:44 pm
JBTX wrote:
Wed Sep 13, 2017 7:36 pm

The only way the match performance, by definition, is they hold proportionately exactly the same thing as the sum total of the active market.
Again, this is incorrect. Any given index funds needs to hold (in an idealized sense, at the margins they won't do it perfectly) each component of the index in the same proportions to their outstanding shares - there is no reference point to the active market at all that they need to keep to, they are indifferent to whether other holders of shares are active or passive holders (if they could even figure it out).
It is impossible to reconcile what you just said, to this from Buffett:

Buffett's main reasoning in favor of index fund investing, and for S&P 500 index funds in particular, is that by definition, they will match the market's performance over time -- no more, no less. And with rock-bottom management expenses, investors will be the beneficiary of virtually all of the gains -- not investment managers.

The ONLY way you match the market's performance, is you exactly what the market does (or the slice of the market that the index is tracking).

All total market index funds are materially the same thing. So what they are ultimately mirroring is the active market in totality.

Here is the full Buffett quote:

https://www.forbes.com/sites/robertberg ... 89e8543fad
So that was my argument – and now let me put it into a simple equation. If Group A (active investors) and Group B (do-nothing investors) comprise the total investing universe, and B is destined to achieve average results before costs, so, too, must A. Whichever group has the lower costs will win. (The academic in me requires me to mention that there is a very minor point – not worth detailing – that slightly modifies this formulation.) And if Group A has exorbitant costs, its shortfall will be substantial.
I think what is getting all of you up in a wad is me saying passive = active. I understand that indexes follow the total market, which includes passive plus active. They aren't explicitly trying to track the active market. But passive is pretty much all the same thing. Ultimately they have to follow something, and what is left is the active market - which includes all active funds, hedge funds, pension funds, individual traders, etc, etc. A total market index fund will effectively end up mirror the sum total of all of those active parts.

Hopefully this clarifies it.

avalpert
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Joined: Sat Mar 22, 2008 4:58 pm

Re: Larry Swedroe: New Passive Criricism Fails

Post by avalpert » Wed Sep 13, 2017 8:28 pm

JBTX wrote:
Wed Sep 13, 2017 8:10 pm
avalpert wrote:
Wed Sep 13, 2017 7:44 pm
JBTX wrote:
Wed Sep 13, 2017 7:36 pm

The only way the match performance, by definition, is they hold proportionately exactly the same thing as the sum total of the active market.
Again, this is incorrect. Any given index funds needs to hold (in an idealized sense, at the margins they won't do it perfectly) each component of the index in the same proportions to their outstanding shares - there is no reference point to the active market at all that they need to keep to, they are indifferent to whether other holders of shares are active or passive holders (if they could even figure it out).
It is impossible to reconcile what you just said, to this from Buffett:

Buffett's main reasoning in favor of index fund investing, and for S&P 500 index funds in particular, is that by definition, they will match the market's performance over time -- no more, no less. And with rock-bottom management expenses, investors will be the beneficiary of virtually all of the gains -- not investment managers.

The ONLY way you match the market's performance, is you exactly what the market does (or the slice of the market that the index is tracking).

All total market index funds are materially the same thing. So what they are ultimately mirroring is the active market in totality.
It is true that the passive funds are (trying to at least) mirror the total performance of the index they are covering, and that does mean they will (should) have the same before-fee returns as all actively traded dollars. That isn't the same thing though as saying they are mirroring active trades - which is what your mistaken hypothetical had them doing.
I think what is getting all of you up in a wad is me saying passive = active.
No, what is getting me up in a wad is that you keep msicharacterizing the mechanics of passive index funds. The market price adjusts automatically when a trade is made (at least for valuation purposes in mark-to-market securities, which is what we are dealing with here) - no passive fund needs to take any action just because an active trader reduces their shares by selling, the market price adjusts and there proportional ownership of the security stays the same - this is true even if all active investors sell all their shares, passive funds still do not need to take any action to maintain their proportional ownership of the market cap.

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