Larry Swedroe: Indexing Fuss Unwarranted

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Random Walker
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Larry Swedroe: Indexing Fuss Unwarranted

Post by Random Walker » Mon Apr 02, 2018 9:13 am

http://www.etf.com/sections/features-an ... nopaging=1

Larry reviews the prevalence of indexing in today’s markets. About 20% of invested funds are indexed. The article starts out with the attacks from active managers that indexers are free loaders destroying the price discovery process. Larry shows that we are very very far away from that. He reviews the important social function provided by active management: price discovery and efficient allocation of capital. Larry reviews the costs of active management and finishes off discussing one of the weaknesses of indexing along with distinguishing indexing from passive investing.

Dave

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mickeyd
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Re: Larry Swedroe: Indexing Fuss Unwarranted

Post by mickeyd » Mon Apr 02, 2018 11:57 am

Thanks for that link Dave.
Passive investors are “free riders.” They receive all the benefits from the role that active managers play in making the financial markets efficient without having to pay their costs.
This is a point that we passive investors often fail to account for.

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Re: Larry Swedroe: Indexing Fuss Unwarranted

Post by dumbmoney » Mon Apr 02, 2018 12:39 pm

Active management is profitable, just not for investors. But that's how it should be! If the world were in perfect equilibrium, active and passive funds would have the same return. The reason is simple: the risk (for a diversified investor) is the same.
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Re: Larry Swedroe: Indexing Fuss Unwarranted

Post by Chuck » Mon Apr 02, 2018 12:57 pm

When I buy motor oil at Walmart, I don't necessarily check the price at Auto Zone, or NAPA, or anywhere else. I just assume there are enough other people checking prices and and shifting demand that I should be getting a "pretty good price." I am a price discovery freeloader in more than just mutual funds.

Random Walker
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Re: Larry Swedroe: Indexing Fuss Unwarranted

Post by Random Walker » Mon Apr 02, 2018 3:00 pm

Chuck,
I make the same assumptions

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Re: Larry Swedroe: Indexing Fuss Unwarranted

Post by Independent George » Mon Apr 02, 2018 3:11 pm

I think it is true that there does come a point where if the indexes are too prevalent, it does cause price discovery to break down. However, when that happens, I would expect to see actively managed funds to start outperforming the indexes and fees to increase to the point where money will start chasing those returns.

In other words, I feel like it's a largely self-regulating process - the natural equilibrium point would be if 50% of active funds beat the indexes after fees, and 50% did not.

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Re: Larry Swedroe: Indexing Fuss Unwarranted

Post by Chuck » Mon Apr 02, 2018 3:15 pm

YES!!

Saying that prices will go haywire because everyone is indexing is the same as saying that exploitable pricing anomalies will go unexploited.

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Re: Larry Swedroe: Indexing Fuss Unwarranted

Post by PVW » Mon Apr 02, 2018 3:45 pm

Passive investors make it easier and more profitable to exploit pricing inefficiencies. It removes competition for discovery and also increases the available pool of mispriced assets so that an active investor can buy more before the herd discovers the inefficiency.

A skilled active investor would welcome this. People who make money off investors would not welcome this.

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Re: Larry Swedroe: Indexing Fuss Unwarranted

Post by Artful Dodger » Mon Apr 02, 2018 4:02 pm

I noticed when reviewing the Local BH chapters sub-forum that Larry is giving a talk at the St. Louis Public Library on the 26th. I added to my calendar, and plan to attend.

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Re: Larry Swedroe: Indexing Fuss Unwarranted

Post by Random Walker » Mon Apr 02, 2018 4:09 pm

The competition only gets tougher and tougher. If people leave active to jump on the passive bandwagon, the investors remaining active will be the winning best. And they will be left to compete against one another. The way I see it, as long as there are a few highly skilled active investors remaining at the margin, passive investing is the winning game.

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Re: Larry Swedroe: Indexing Fuss Unwarranted

Post by alfaspider » Mon Apr 02, 2018 4:17 pm

Independent George wrote:
Mon Apr 02, 2018 3:11 pm
I think it is true that there does come a point where if the indexes are too prevalent, it does cause price discovery to break down. However, when that happens, I would expect to see actively managed funds to start outperforming the indexes and fees to increase to the point where money will start chasing those returns.

In other words, I feel like it's a largely self-regulating process - the natural equilibrium point would be if 50% of active funds beat the indexes after fees, and 50% did not.
Exactly. There will never be an index fund apocalypse. If too many people index, then the there will be legitimate alpha in active trading, and over time more people will seek it.

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Re: Larry Swedroe: Indexing Fuss Unwarranted

Post by gmaynardkrebs » Mon Apr 02, 2018 5:05 pm

Free-riding is a market externality, which means that there will be a suboptimal amount of resources devoted to research. There is no way around that. Note how measles and mump are coming back. At some point, things fall apart. The question is, how close are we to that point in today's environment? Much "active" investing is passive investing with a few tweaks. So the amount of passive investing is quite a bit more than just counting up the percentage of explicitly passive funds.

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Re: Larry Swedroe: Indexing Fuss Unwarranted

Post by nisiprius » Mon Apr 02, 2018 5:32 pm

Nobody ever complains that the people who habitually buy their groceries in the nearest supermarket are free-riding on the hard work of the people who comparison shop.
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Re: Larry Swedroe: Indexing Fuss Unwarranted

Post by gmaynardkrebs » Mon Apr 02, 2018 8:47 pm

nisiprius wrote:
Mon Apr 02, 2018 5:32 pm
Nobody ever complains that the people who habitually buy their groceries in the nearest supermarket are free-riding on the hard work of the people who comparison shop.
What you are referring to is consumer surplus, which is very different and unrelated to any externality. In competitive markets, producers have no choice but to sell to the entire demand curve curve at the same price. Grocery stores are monopolistic competitors, which ultimately come close to the selling at or near the competitive pricce,
Last edited by gmaynardkrebs on Mon Apr 02, 2018 10:31 pm, edited 2 times in total.

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Taylor Larimore
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Re: Larry Swedroe: Indexing Fuss Unwarranted

Post by Taylor Larimore » Mon Apr 02, 2018 9:35 pm

Bogleheads:

In my opinion, there will always be managed funds for two primary reasons:

1. The investment industry spends billions of dollars each year telling us that what they are selling can "beat the market" -- although the record is clear that as a group they cannot "beat the market." Nobel Laureate Wm. Sharpe explains:

The Arithmetic of Active Management

2. Most new investors (and many experienced investors) falsely believe they know how to "beat the market." Some do because of luck. Unfortunately, most investors and professional fund managers don't beat the market. They do worse--often much worse.

SPIVA U.S. Year-End 2017 Scorecard

Best wishes.
Taylor
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Re: Larry Swedroe: Indexing Fuss Unwarranted

Post by cfs » Mon Apr 02, 2018 10:21 pm

Thank you Mister Dave for the link to the article. Another good article by Mister Swedroe (he is no longer active in this forum, our loss). Good luck y gracias por leer / cfs
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Re: Larry Swedroe: Indexing Fuss Unwarranted

Post by Independent George » Tue Apr 03, 2018 10:57 pm

alfaspider wrote:
Mon Apr 02, 2018 4:17 pm
Exactly. There will never be an index fund apocalypse. If too many people index, then the there will be legitimate alpha in active trading, and over time more people will seek it.
Actually, the more I think about it, the more I think my own statement is wrong, too. 50% of active funds beating the indices and 50% losing is inherently unstable, because loss aversion would lead more people to stick with the indices than have a 50% chance of under-performing even if the expected outcome is the same.

I think a more stable equilibrium would be if, say, 75% of the active traders under-performed, but the 25% who beat the market tended to beat it by a very, very large margin. The reward would have to be high enough to be an incentive for taking that risk on active management. On the other hand, I suppose that's why people currently invest in hedge funds despite the crazy fees and high risks; just enough of them are so wildly successful that people delude themselves into thinking they can spot next one to do the same despite the odds.

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