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Only Good Argument Against Indexed Funds

Posted: Wed Oct 09, 2019 7:59 am
by laidback_and_relaxed
This Reuters article posted on Yahoo Finance is the 1st and only good argument I’ve seen against passive funds (and ETFs?). Basically it says that passive funds don’t weigh in on management issues like management compensation and such, letting poorly run companies get away with more. The article compares passive investment funds with active funds where even if the custodian for an active investment fund (or ETF?) isn’t actively voting on issues via proxies, they’re voting with their investment dollars and moving to other options.

https://finance.yahoo.com/news/special- ... 12503.html

The rational isn’t enough for me to change my preference for passive ETFs and funds over active, but raises a red flag for me.

Re: Only Good Argument Against Indexed Funds

Posted: Wed Oct 09, 2019 8:26 am
by CnC
laidback_and_relaxed wrote:
Wed Oct 09, 2019 7:59 am
This Reuters article posted on Yahoo Finance is the 1st and only good argument I’ve seen against passive funds (and ETFs?). Basically it says that passive funds don’t weigh in on management issues like management compensation and such, letting poorly run companies get away with more. The article compares passive investment funds with active funds where even if the custodian for an active investment fund (or ETF?) isn’t actively voting on issues via proxies, they’re voting with their investment dollars and moving to other options.

https://finance.yahoo.com/news/special- ... 12503.html

The rational isn’t enough for me to change my preference for passive ETFs and funds over active, but raises a red flag for me.
I'll play along with management issues.

Let's talk about poorly run companies.
GE this had management issues and despite the fact that GE had always been in the sp 500 and thus a big part of virtually every index fund they have been held to task so much so they lost their sp500 ranking and stock prices have halved.

Re: Only Good Argument Against Indexed Funds

Posted: Wed Oct 09, 2019 8:31 am
by vineviz
laidback_and_relaxed wrote:
Wed Oct 09, 2019 7:59 am
This Reuters article posted on Yahoo Finance is the 1st and only good argument I’ve seen against passive funds (and ETFs?). Basically it says that passive funds don’t weigh in on management issues like management compensation and such, letting poorly run companies get away with more. The article compares passive investment funds with active funds where even if the custodian for an active investment fund (or ETF?) isn’t actively voting on issues via proxies, they’re voting with their investment dollars and moving to other options.

https://finance.yahoo.com/news/special- ... 12503.html

The rational isn’t enough for me to change my preference for passive ETFs and funds over active, but raises a red flag for me.
It's not a good argument.

For one thing, all the largest managers of index funds also operate actively managed funds and I guarantee there is no significant difference in the way the managers of one set of funds vote relative to other set.

If anything, it seems like the firms mentioned in the article are actually MORE likely to challenge management than the average active manager. According to the article, "BlackRock voted with management 93% of the time, followed by Vanguard at 91% and State Street at 84%" but the average rate for all mutual funds is 94% according to the Investment Company Institute. Most likely this is because active managers have closer personal relationships with company management, by virtue of the fundamental research they do.

Furthermore, it is a mathematical necessity that the aggregate holdings of active managers exactly matches the aggregate holdings of index funds. So there is no "voting with their feet" benefit for one group that doesn't also apply to the other group.

Re: Only Good Argument Against Indexed Funds

Posted: Wed Oct 09, 2019 8:34 am
by Ferdinand2014
laidback_and_relaxed wrote:
Wed Oct 09, 2019 7:59 am
This Reuters article posted on Yahoo Finance is the 1st and only good argument I’ve seen against passive funds (and ETFs?). Basically it says that passive funds don’t weigh in on management issues like management compensation and such, letting poorly run companies get away with more. The article compares passive investment funds with active funds where even if the custodian for an active investment fund (or ETF?) isn’t actively voting on issues via proxies, they’re voting with their investment dollars and moving to other options.

https://finance.yahoo.com/news/special- ... 12503.html

The rational isn’t enough for me to change my preference for passive ETFs and funds over active, but raises a red flag for me.
P/E ratio of Netflix: 107
P/E ratio of JP. Morgan: 11

Disagree or not about the relative valuations, they are both in the S&P 500. Price discovery and therefore buying or selling based on overall management and growth prospects in my opinion are still actively pursued. I would say that's voting with their investment dollars. Vanguard is very clear that they take their voting proxy seriously to the betterment of the mutual fund owners.

Re: Only Good Argument Against Indexed Funds

Posted: Wed Oct 09, 2019 9:32 am
by firebirdparts
It's a lie, basically. The fund managers are actively voting. The article is saying "I can in my wisdom nitpick how they voted". You certainly can. No question. Sadly, actively managed funds also vote the same way. I can nitpick how they vote too. Most folks don't have quite so many votes.

Indexing is not the problem, as always. Rather, indexing creates an opportunity to challenge management. They complaint here is that they weren't quick enough to use it. Active funds don't even have the ability.

For instance: Lund said in an interview. “The problem is going to be greater as these index funds get more money,” The reality is that the opportunity is going to be greater as these index funds get more money.

I never looked at this before:
https://about.vanguard.com/investment-s ... nds-voted/

Re: Only Good Argument Against Indexed Funds

Posted: Wed Oct 09, 2019 2:36 pm
by nisiprius
Does the market care about "poorly run companies?" If so, then index funds do care about poorly run companies.

Re: Only Good Argument Against Indexed Funds

Posted: Wed Oct 09, 2019 2:46 pm
by student
Essentially, the argument to me is index funds are buying some losers. But it is exactly what index funds are designed for, buying losers and winners because it is difficult to pick winners. Actually, the active mangers should love this as they can now buy only winners and let the suckers (index funds) left holding the bag.

Re: Only Good Argument Against Indexed Funds

Posted: Wed Oct 09, 2019 3:36 pm
by asset_chaos
Poor management, good management, is it really that easy to tell? Is there an obvious metric that classifies poorly managed (or is that manged) from well managed companies? And, if there is, does the management metric predict stock returns? Seems ripe for a new factor: GmB (good minus bad), long well managed, short poorly managed. Active fund managers (ignoring for the moment the meta-problem of the fund companies being themselves well or poorly managed) would only invest in well managed companies and beat the pants off index funds. Could it be just that simple?

Re: Only Good Argument Against Indexed Funds

Posted: Wed Oct 09, 2019 4:33 pm
by Workable Goblin
asset_chaos wrote:
Wed Oct 09, 2019 3:36 pm
Poor management, good management, is it really that easy to tell? Is there an obvious metric that classifies poorly managed (or is that manged) from well managed companies?
Well, the article itself points out some examples of, let us say, very obviously questionable management decisions, mostly tied to extremely high executive pay levels. For instance, CSX is cited as paying an enormous amount of money as a signing bonus to a very elderly and ill chief executive, who promptly died less than a year later. Perhaps not all management decisions are so obviously bad as spending tens of millions of dollars hiring someone who is unlikely to live more than a few years, but I doubt 93% of them are worth approving.

(But then, I have a poor opinion of business executives in general, so I would think that)

Re: Only Good Argument Against Indexed Funds

Posted: Wed Oct 09, 2019 4:45 pm
by David Jay
Workable Goblin wrote:
Wed Oct 09, 2019 4:33 pm
Well, the article itself points out some examples...
Some wag has quipped that the plural of anecdote is not data.

There are always examples, usually benefitting from hindsight. But evaluating future company performance is difficult, check out “A Random Walk Down Wallstreet”.

Re: Only Good Argument Against Indexed Funds

Posted: Wed Oct 09, 2019 4:57 pm
by Workable Goblin
David Jay wrote:
Wed Oct 09, 2019 4:45 pm
Some wag has quipped that the plural of anecdote is not data.
Some wag, indeed. But an anecdote is quite enough to prove that in some cases things turn out a certain way, which is all that's being looked for here. In some cases it is absolutely possible to see that management is making bad decisions that the shareholders ought not go along with.
David Jay wrote:
Wed Oct 09, 2019 4:45 pm
There are always examples, usually benefitting from hindsight. But evaluating future company performance is difficult, check out “A Random Walk Down Wallstreet”.
Of course it's difficult, that doesn't mean that we can't be skeptical that paying a 72-year old man in poor health $84 million to become CEO is a good idea. Or, for that matter, whether giving a CEO a 100%+ raise after running a company into the ground as opposed to firing them is wise. Actually, the difficulty of evaluating future company performance tends to make the article's point sharper, because why should we expect management to have any clue as to improving future company performance, as opposed to the much easier task of lining their own pockets? (Indeed, nearly all of the examples cited had to do with pay packages) Shouldn't we then be very skeptical of all management proposals, instead of overwhelmingly voting in favor of them?

Re: Only Good Argument Against Indexed Funds

Posted: Thu Oct 10, 2019 8:47 am
by David Jay
Workable Goblin wrote:
Wed Oct 09, 2019 4:57 pm
David Jay wrote:
Wed Oct 09, 2019 4:45 pm
Some wag has quipped that the plural of anecdote is not data.
Some wag, indeed. But an anecdote is quite enough to prove that in some cases things turn out a certain way, which is all that's being looked for here. In some cases it is absolutely possible to see that management is making bad decisions that the shareholders ought not go along with.
David Jay wrote:
Wed Oct 09, 2019 4:45 pm
There are always examples, usually benefitting from hindsight. But evaluating future company performance is difficult, check out “A Random Walk Down Wallstreet”.
Of course it's difficult, that doesn't mean that we can't be skeptical that paying a 72-year old man in poor health $84 million to become CEO is a good idea. Or, for that matter, whether giving a CEO a 100%+ raise after running a company into the ground as opposed to firing them is wise. Actually, the difficulty of evaluating future company performance tends to make the article's point sharper, because why should we expect management to have any clue as to improving future company performance, as opposed to the much easier task of lining their own pockets? (Indeed, nearly all of the examples cited had to do with pay packages) Shouldn't we then be very skeptical of all management proposals, instead of overwhelmingly voting in favor of them?
Management does lots of “stupid” things that do not take the form of proposals to shareholders.

Re: Only Good Argument Against Indexed Funds

Posted: Thu Oct 10, 2019 2:08 pm
by firebirdparts
I always go back in my mind to Bob Nardelli being paid $210 million to "please go away". Has anybody ever topped that? Of course he made about $240. Evidently the directors thought he was worth that. I mean, before they fired him.

Re: Only Good Argument Against Indexed Funds

Posted: Thu Oct 10, 2019 4:23 pm
by JBTX
Poorly run companies are likely value stocks. Presumably the price reflects this.

In terms of other funds based upon various value judgments, that's fine if you want to go there, but not all values are important to everybody. Also, it is easier to be "green" if you are a tech web company vs a manufacturer.

Re: Only Good Argument Against Indexed Funds

Posted: Thu Oct 10, 2019 7:11 pm
by Geologist
There have been a number of posters saying that there are poorly run companies. Of course, there are.

However, what reason do we have to believe that managers of active funds can change the behavior of poorly performing companies or avoid them? It is not enough to assert that they could do so. Where is the evidence that they do it? There are decades of history of active funds and they haven’t outperformed. That is enough evidence for me that active managers aren’t effective at this.