How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

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Rus In Urbe
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How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by Rus In Urbe »

Lately I've been wondering about macro-economic questions that come out of the news that Vanguard had taken in more than its next 8 competitors, a staggering $823 billion (and counting)...as opposed to the piddling $97 billion of the next eight firms. Those numbers, from August, are higher now of course. https://www.nytimes.com/2017/04/14/busi ... .html?_r=0

1. What's the effect of so many Indexers in the market when there comes the downturn? Logic would dictate that, given that Indexers tend to be buy-and-hold and even buy-on-the-dips, their presence in such large numbers might be a stabilizing influence?

2. Thinking about this, got me to look to see how much of the market is now Index/passive investing
According to Black Rock, 17.5% of the market is tied up in indexing. And that might be understated.
https://seekingalpha.com/article/411186 ... ed-indexes
And this data was covered in with an interesting headline in Reuters: Less that 18% of global stocks owned by Index Investors....
https://www.reuters.com/article/us-glob ... SKBN1E600R
As a writer and a journalist, I was particularly struck by the use of "less than" in that headline----because the growth of indexing is relatively new (over the past decades that is) and growing exponentially, the headline should have read "has grown to as much as...." or "has now reached..." The bias of most financial writers (and the whole Wall Street crowd) against Indexing (which threatens those high fees that have made WS so golden) comes out in odd ways.

3. But the question that really intrigues me is that if or when Indexing becomes the norm, or the preponderance, of investing, what effects it has on the market in general. Here, I speak not of the wonderful low-cost nature of its fees and that effect on the individual purse (thanks Jack Bogle). But rather on how buying into the market broadly, rather than individually by company, flattens out the prices between companies, makes value/growth analyses have less traction.

4. Along those lines, did anyone read this report or have access to it?...(from Reuters)
"A report last year by broker-dealer Sanford C. Bernstein & Co LLC described passive investing as promoting a system of capital allocation worse than both capitalism and Marxism in which shares in the biggest companies are bought blindly."
Of course, someone who has spent a life as a broker-dealer is going to be terrified by the Vanguard Effect, that actually ends the way of life for those investment guys, and there is a certain amount of hysteria built into all this, so I would take this with a pound of salt.

5.It appears that even Saint Jack himself is astounded by the growth of Vanguard in the past couple of years.

Interested in any thoughts on the above.....
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Re: How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by Pajamas »

Assuming that all of the criticism of passive index investing is true, then should it be avoided by the average investor? If so, what is the better alternative?

That's the real issue.
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Re: How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by Call_Me_Op »

There are lots of other questions you should be asking, such as how will high-speed trading and trading algorithms (that can result in positive feedback) affect the market.

I have zero worry holding index funds. Note the word "holding" - not trading, not panic selling, but holding. After all, the value of my shares is ultimately reflective of the value of the underlying businesses.
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Re: How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by Da5id »

Pajamas wrote: Wed Dec 13, 2017 7:53 am Assuming that all of the criticism of passive index investing is true, then should it be avoided by the average investor? If so, what is the better alternative?

That's the real issue.
I see the complaints about corporate governance as having some validity. Having over half the ownership of a public company being indexes who shouldn't want to spend time/money figuring out how to vote in the best interest of the shareholders for proxies may be a problem. Certainly as an index owner I don't want my index fund spending lots of money on those issues and driving up expenses, that is the joy of being passive.

As to the market distortions/pricing inaccuracy driven by indexing, OK. Sure it is possible decrease in accuracy of pricing discovery may happen at some level of index ownership. Seems self correcting, in that if indexes blind market cap based buying is resulting in "mispricing" of shares that can be figured out by some active investor(s), seems like mispricing will be fixed. This problem will be revealed with SPIVA shows that a steadily increasing percentage active funds are outperforming indexes after costs, wake me up when that happens :)
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Re: How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by Rus In Urbe »

Don't get me wrong.

I'm an indexer and not worried at all about holding them personally, and I certainly feel they are the best options for me as an individual investor. And, yes, the technical instant-trading created the mess of day-trading and continues to speed up that part of the casino, er, market.

But to be clear, my questions are in the realm of macro-economics---I'm interested in hearing what people think the large-scale effect of indexing will be in the long run. Stabilization perhaps in the short run----but in the long run? Or if anyone has seen anything written on this (that's not penned by self-interested and threatened WS investment-guys).
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Re: How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by overthought »

Rus In Urbe wrote: Wed Dec 13, 2017 8:08 am I'm interested in hearing what people think the large-scale effect of indexing will be in the long run. Stabilization perhaps in the short run----but in the long run? Or if anyone has seen anything written on this (that's not penned by self-interested and threatened WS investment-guys).
My pipe dream is that widespread index investing would force financial advisors who offer active portfolios to put their money where their mouth is: You (broker) and I (client) agree on the benchmark index of interest, and your goal is to beat the index. You take half the difference as your winnings and give me the rest. No other fees or commissions. Trading costs and ER of funds you choose just counts against your return, choose them wisely. The catch, though, is if you lag the index you pay me half the difference. :twisted: Oh, you don't like that deal? Then I'll just go back to my index funds and rebalancing annually, thank you very much!

What I actually expect will happen is the private hedge funds and Buffets of the world (those with lots of cash and patience), will be more than happy to quietly exploit whatever arbitrage the index investing majority leave on the table for them. Individual investors won't have the number crunching prowess, split second reaction times, insider knowledge, and/or capital to do well at that game, so they'll continue to ride the index. Not super rosy, but perhaps better than the average investor being taken for a ride by their financial advisor?
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Re: How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by k66 »

I’m inclined to believe that although indexing may have become more popular (both in terms of total dollar invested per individual and the total number of individuals utilizing indexing), it’s not necessarily the case that all indexers will toe the line during a downturn.

I think that there will be a good chance that it will remain “business as usual” with panic selling being the order of the day.
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Re: How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by JBTX »

Rus In Urbe wrote: Wed Dec 13, 2017 8:08 am Don't get me wrong.

I'm an indexer and not worried at all about holding them personally, and I certainly feel they are the best options for me as an individual investor. And, yes, the technical instant-trading created the mess of day-trading and continues to speed up that part of the casino, er, market.

But to be clear, my questions are in the realm of macro-economics---I'm interested in hearing what people think the large-scale effect of indexing will be in the long run. Stabilization perhaps in the short run----but in the long run? Or if anyone has seen anything written on this (that's not penned by self-interested and threatened WS investment-guys).
It is an interesting thought exercise. Whenever it comes up some in here think it is an attack on indexing and it certainly isn’t. But clearly if everybody indexed the market would not work. It is kind of like the paradox of saving quoted by Keynes. Individuals can and should save money. But the more everybody saves the less economic activity and the poorer everybody gets.

My gut tells me that while indexing will increase I doubt practically there will be a major negative impact. Ultimately there has to be an active market to determine the prices for index funds and there will always be an active market. At what ratio of passive to active does market behavior start to change? If 80-90% of market is passive and relies on 10% active market to set prices, is there a practical impact of that? I honestly don’t know. It may have some impact but no more than other types of market “innovation” such as program/ automated trading or high speed trading.

I agree it is interesting to think about th governance aspect. If most investors just own the market and don’t care about individual stocks, is that bad, or good, or both? While it would seem bad to have disinterested shareholders but on the flip side maybe investors become more long term in nature
And that drives companies to look beyond quarterly earnings cycles.

Also in the past if you owned Coke you probably didn’t own Pepsi. Now you likely own both with indexing. Is that good or bad? Does company management treat shareholders differently that hold all of their competitors too? Do companies become more “collaborative” to suit their market owning shareholders, at least to the extent of not violating anti trust laws? If a shareholder owns the market their concern is overall market earnings increase. They aren’t concerned that coke is beating Pepsi. A price war between coke and Pepsi is not in the best interest of a shareholder who owns the entire market. Does company management respond to their shareholder interests or continue to operate in an adversarial competitive mode?
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Re: How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by JBTX »

Phineas J. Whoopee wrote: Wed Dec 13, 2017 6:38 pm What if everybody indexed?
PJW
There are threads going back 10 years but somehow the market is still functioning.
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Re: How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by David Jay »

Rus -

If indexing becomes so popular that it interferes with price discovery to such an extent that the impact becomes exploitable, I will be among first to exploit it. Thus, the issue is self-resolving.
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Re: How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by KSActuary »

David Jay wrote: Wed Dec 13, 2017 10:36 pm Rus -

If indexing becomes so popular that it interferes with price discovery to such an extent that the impact becomes exploitable, I will be among first to exploit it. Thus, the issue is self-resolving.
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Re: How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by bottlecap »

This stuff is discussed often here, mostly because of articles that pop up written by those that sell active funds.

In most cases, you don't need that many active participants to keep a market efficient.

Nonetheless, as others have said or implied, indexing won't "stop working," because the minute there is a whiff in the air suggesting it results in exploitable inefficiencies, there are plenty of people who will step in, be active, and solve the problem before anyone else notices it exists.

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Re: How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by sandramjet »

Rus In Urbe wrote: Wed Dec 13, 2017 7:45 am Lately I've been wondering about macro-economic questions that come out of the news that Vanguard had taken in more than its next 8 competitors, a staggering $823 billion (and counting)...as opposed to the piddling $97 billion of the next eight firms. Those numbers, from August, are higher now of course. https://www.nytimes.com/2017/04/14/busi ... .html?_r=0

1. What's the effect of so many Indexers in the market when there comes the downturn? Logic would dictate that, given that Indexers tend to be buy-and-hold and even buy-on-the-dips, their presence in such large numbers might be a stabilizing influence?

2. Thinking about this, got me to look to see how much of the market is now Index/passive investing
I'm not worried about indexing causing problems, at least in my timeframe. But one thing to remember is that while Vanguard is certainly known for index funds, they have plenty of active managed funds as well (both bond and stock), and are adding more. So not all of that money is necessarily pouring into just indexing.
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Re: How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by garlandwhizzer »

There are some things about investing that are worthy of serious concern. That indexing will ruin the market's ability to function is not one of them IMO. Those that promote such a belief usually have a financial interest in doing so. As others have pointed out, as soon as there exploitable market inefficiencies develop, active investor money flows in that direction diminishing that inefficiency. It is entirely consistent with human psychological makeup to repeatedly and persistently attempt to beat the market even though simple arithmetic says that on average those who choose to do so will lose. This fuel has always reliably produced billions in needless fees and expenses for the financial industry and will continue to do so until human nature itself changes.

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Re: How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by David Jay »

garlandwhizzer wrote: Thu Dec 14, 2017 10:42 amThis fuel has always reliably produced billions in needless fees and expenses for the financial industry...
You mean like: "Where are the Customer's Yachts?", which was published in the 1940s?
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Re: How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by Sandtrap »

The entire financial market is about 300 "Trillion" dollars.
Vanguard is at 4.5 Trillion but not all of it is in indexing. And, as of 2017, passive funds make up 29% of the market.
In 2016, passive funds in the United States attracted $506 billion, and actively managed funds posted $341 billion in withdrawals, according to Morningstar Inc. Some articles predict passive funds will reach 50% of the market by 2024. But it is just a guess. Nobody knows.
But, it is not in the financial industry's best interest (loss of profits) to see passive funds "take over" the market. That's the "elephant in the room". And so, as "garland whizzer" put forth, it ain't gonna happen.
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Re: How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by nisiprius »

To state what should be obvious: indexing the total market at cap-weight is different from every other strategy because it is the only one that does not encounter obvious problems if almost everybody does it.

For example, if almost everybody wanted 30% of their holdings to be small-cap value, you would have a problem because small-cap value is only 2% of the market. The market will run out of small-cap value long before everyone could get what they want. In fact, not even 7% of investors' dollars can be invested that way, because if 7% of investors' dollars were invested in 30% small-caps, that would use require a supply equal to 2.1% of the market and there isn't that much. Presumably, if everybody tried to put 30% of their portfolio into small-cap value, that would soon drive up the price of small-cap value stocks to the point where any alleged premium would disappear.

But almost everybody can have a total market indexed portfolio, because you are not selectively reducing or otherwise changing what is available to everybody else... and among other things you are not creating selective shortages that will drive up the prices of asset classes.
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Re: How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by Quak90 »

Central to the indexing theory is the notion that market forces are self-correcting, so in the long-run it all corrects to the positive. In the short-run there could be some inefficiencies, but if you re-balance you become the beneficiary of those inefficiencies, so I'm not sure how as an indexer you lose out here...unless you stop indexing and in an inefficient short-run (whatever form that takes) you stop re-balancing.
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Re: How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by garlandwhizzer »

nisi wrote:
For example, if almost everybody wanted 30% of their holdings to be small-cap value, you would have a problem because small-cap value is only 2% of the market. The market will run out of small-cap value long before everyone could get what they want. In fact, not even 7% of investors' dollars can be invested that way, because if 7% of investors' dollars were invested in 30% small-caps, that would use require a supply equal to 2.1% of the market and there isn't that much. Presumably, if everybody tried to put 30% of their portfolio into small-cap value, that would soon drive up the price of small-cap value stocks to the point where any alleged premium would disappear.
1+

Capacity restraints can be a problem for strategies that are selecting narrowly defined slices of the market in the search for outperformance, especially so in the small/micro cap segment of the market. If too much money flows into the same stocks, their valuations suffer and their future performance is also expected to suffer. Cap-weighted TSM on the other hand spreads money into all stocks, most of it going it large/mega cap stocks that have no liquidity issues and can absorb a lot of buying and selling without affecting their price much. Illiquidity itself is in fact a factor. The market pays you to accept the risk of owning something that can be difficult to buy or sell at your convenience. Another way of saying that is that market participants value liquidity and are willing to pay for it. It's nice to be able to sell assets when you actually need the money.

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Re: How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by MotoTrojan »

David Jay wrote: Wed Dec 13, 2017 10:36 pm Rus -

If indexing becomes so popular that it interferes with price discovery to such an extent that the impact becomes exploitable, I will be among first to exploit it. Thus, the issue is self-resolving.
How will you know? Genuine question. Performance chase active funds that start doing amazingly well?
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Re: How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by CyberGuy »

Market volume is at record highs. Indexing seems to not be having any adverse affects on liquidity or the market.
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Re: How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by David Jay »

MotoTrojan wrote: Thu Dec 14, 2017 6:54 pm
David Jay wrote: Wed Dec 13, 2017 10:36 pm Rus -

If indexing becomes so popular that it interferes with price discovery to such an extent that the impact becomes exploitable, I will be among first to exploit it. Thus, the issue is self-resolving.
How will you know? Genuine question. Performance chase active funds that start doing amazingly well?
Not funds. Individual stocks. That are part of major indexes (say, SP500) and are being lifted (or pulled down) far beyond what the fundamentals indicate.

I used to hold a lot of individual stocks (I am down to 2 companies and I am looking for the appropriate time to sell them as well). It is no longer worth the time or effort to me to stay on top of these companies.
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Re: How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by in_reality »

MotoTrojan wrote: Thu Dec 14, 2017 6:54 pm
David Jay wrote: Wed Dec 13, 2017 10:36 pm Rus -

If indexing becomes so popular that it interferes with price discovery to such an extent that the impact becomes exploitable, I will be among first to exploit it. Thus, the issue is self-resolving.
How will you know? Genuine question. Performance chase active funds that start doing amazingly well?
I think there is a common misunderstanding that "index funds" means "market cap weighting".

If you want now, and some on this board recommend it, you can buy any number of ETFs that will systematically screen the market and limit it's holdings to a particular subset - whether that's companies with growing dividends, companies with fundamentals you like (profitability, P/E, B/M), companies in a particular sector or country, etc. etc.

I mean there are what 62 tech ETFs now with a wide range of focuses.

So even a few traders will change prices, and that will be seen in ETF performance based on the funds' methodology. And so the popularity of various ETF's strategies will affect price discovery.

I see the ETF industry launching new products constantly probably trying to capture a period of outperformance and attracting inflows and closing if not (with a record number of both opening and closings recently).

In fact, I'd argue that some segments are probably priced better today. How many traders historically have been focused on small caps particularly value? Certainly now there are an increasing number of funds analyzing the whole space constantly. Sure it's a systematic analysis and not as idiosyncratic as individual traders are, but the fact is that the market is being systematical analyzed today for any and everything that could offer better results. And new funds are popping up for anyone willing to take the risk. And so I don't think passive investing means ignoring price discovery at all.
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Re: How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by arcticpineapplecorp. »

read all about it:

viewtopic.php?t=225309

the trashing of indexing has been going on for a very long time:

viewtopic.php?t=225309#p3485048
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Re: How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by nisiprius »

You don't need a huge number of participants to perform price discovery; what you need is well-informed, analytical, and shrewd participants. In the year when I bought one share of Target so that I could give the framed stock certificate as a gift to my granddaughter, I was not being a mini-Warren-Buffett, and neither are the vast majority of retail investors who buy individual stocks. Despite Peter Lynch, our expert knowledge of the quality of L'Eggs is not the equivalent of reading a balance sheet. The Beardstown Ladies did not beat the market.

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Re: How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by itstoomuch »

It will be interesting to see what happens. :oops: :?:
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Re: How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by randomizer »

Despite the stabilizing effect of buy-and-hold or buy-on-the-dips indexers (and who knows how many of those there are? it sure is easy to say you're an indexer when it's a bull market and there's easy money to be made), I am pretty sure Wall Street has enough hyper-leveraged, shimmering mirages of derivatives upon derivatives upon derivatives to more than make up for that.

Expecting things to go BOOM or BANG or BORK at some unknown point in the near future (within 5 to 10 years), and probably in a way that is most unlike all the other times things have gone BOOM or BANG or BORK...
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Re: How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by nisiprius »

randomizer wrote: Fri Dec 15, 2017 12:28 am...Expecting things to go BOOM or BANG or BORK at some unknown point in the near future (within 5 to 10 years), and probably in a way that is most unlike all the other times things have gone BOOM or BANG or BORK...
Yes, especially the last part. To riff on Tolstoy (never read the book, but only know the opening sentence), happy markets are all alike; every unhappy market is unhappy in its own way.

During 2000-2002, several so-called "asset classes," notably REITs and small-cap value, conspicuously went up when stocks in general were going down. I think that single time period "made" the reputation of slice-and-dice strategies. It certainly didn't repeat in 2008-2009.
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Re: How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by Top99% »

I guess I would challenge the assumption that most index fund investors are "buy and hold" investors. Certainly during the GFC several of my coworkers panicked and exchanged their 401K equity index funds for bonds or cash. A lot of people are in reality buy and hold "until/unless X or Y happens" regardless of whether they own individual stocks, active funds or index funds.
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Re: How Will Indexers Affect A Downturn---or the functioning of the market in the long-run?

Post by Rus In Urbe »

THANKS to all bogleheads for this excellent discussion. Just to reiterate---my question was not, not, not an attack on indexing (and thanks to writers who pointed out that the direction of this question is usually seen as an attack).

So, after all this, I'm tracking data on volatility especially (and not bitcoin/tulip-type volatility), since, like several others here, I suspect that the rather astonishing % of the market that has flowed into passive investing is going to have an effect on how fast it will rise and fall.

Interesting advice by Jack Bogle on the junk-ETF products now being invented that wear the garb of indexing, but are narrow-cast and easily traded, so lead to market-timing and other money-losing behaviors. As others pointed out, Wall Streeters will continue to invent exotic and complex instruments that will suck in some, um, suckers....

And how about the SEC suspending trades on Crypto-Co.? There's a way to keep it clean.... https://www.bloomberg.com/news/articles ... 2-700-jump
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