
A look behind the scenes at an index fund with Vanguard's Gerry O'Reilly - cookscar
http://www.bloomberg.com/news/articles/2016-08-15/vanguard-s-gerry-o-reilly-offers-a-rare-look-inside-an-index-fund
======
perryh2
After some research in personal finance last week, I moved my balance from
Wealthfront to Vanguard mutual funds/ETFs. I was already using them for my
401k. Their expense ratios are the lowest in the industry and they also have
managed retirement funds you can use to replace Wealthfront if you are lazy.
Here is a quick way to learn about the Bogleheads investment philosophy.

[0]
[https://www.bogleheads.org/wiki/Bogleheads%C2%AE_investment_...](https://www.bogleheads.org/wiki/Bogleheads%C2%AE_investment_philosophy)

~~~
notadoc
I like the idea of Wealthfront but I can't imagine why anyone would pay any
fee for the service.

Perhaps that's why Schwab has a fee free robo advisor, and surely every other
brokerage and bank is working on the same thing.

~~~
rev_bird
I think it probably depends on how much you stand to gain from automated tax-
loss harvesting: If you don't have the time/skills to do it yourself,
strategically selling depreciated stocks (then, potentially, buying them again
later) can cancel out a lot of the taxes you'd pay on gains elsewhere in your
portfolio. If the Wealthfront fee is less than you save, seems like it'd make
sense.

~~~
notadoc
OK, but don't you think the same service will be offered fee-free from robo
advisors from big banks and brokerages? That's my guess, anyway.

~~~
sushid
Do you know of any places that offer this automated service?

~~~
notadoc
Schwab has a free robo advisor, Vanguard has a fee robo advisor, iShares has a
little robo portfolio generator. I'm sure there are others too.

------
matt_wulfeck
> "450 billion Vanguard Total Stock Market Index Fund matches the performance
> of its 3,600-stock benchmark. That means owning stocks whether they’re
> plunging, surging, or unchanged."

They mention some reasons that human decision-makers are needed, but I'm
actually not convinced. Why not just two algo indexes? One tries to get the
best price, the other simply doesn't trade the difficult illiquid stocks?

I'm surprised an enterprising company hasn't come along that allows you to
pick all your own stocks, and allow them to be rolled up in an index. That
kind of service shouldn't be too hard to create from a technical point of
view, so I'm assuming the issue is with regulation.

~~~
ramchip
> I'm surprised an enterprising company hasn't come along that allows you to
> pick all of our stocks, and allow them to be rolled up in an index.

Do you mean basket trading?
[https://www.interactivebrokers.co.jp/jp/?f=/en/trading/order...](https://www.interactivebrokers.co.jp/jp/?f=/en/trading/orders/basket.php)

~~~
ryandrake
It's not entirely clear from that site, but it looks like they just let you
batch up a bunch of separate orders in a single spreadsheet, and execute each
one of them.

The grandparent post seems to be calling for a service that lets me say, "I'd
like to start my own custom-ETF, consisting of A% Facebook, B% AT&T, C%
Walmart, D% McDonalds, etc." and then let me invest money that "fund" every so
often. I agree this would be a neat service. Currently, if you want a
portfolio of specific diversified stocks, you have to either 1. Find a fund
that is similar enough to the basket of stocks that you would like or 2.
Purchase each stock individually (getting eaten up in commission fees). Both
are less than ideal.

~~~
fibbery
Motif investing does that exactly.

------
spitfire
The risk with ETF index funds is when the market truly deteriorates ETF's can
simply fall apart. Particularly in illiquid or quickly falling markets.

There was a paper about this a year or two ago which I'm unable to find now.
I'd caution risk for anyone planning on using ETF's to ride out a storm.

EDIT: I'll have to see if I can find the paper again. The basic summary was
that in situations like 2008 ETF's failed in ways that were materially worse
than holding the same basket of assets.

But this is not investment advice. Make up your own mind and plan according to
your risk tolerances.

~~~
FreedomToCreate
Almost every investment deteriorates when the market does. In terms of
stability and long term gains, ETFs are the best bet. You have to be willing
to take high risk if you want to invest in things that are not affected by
market deterioration, and many people don't have the ability to take that
risk. Overall, anyone reading these comments, please take all investing advice
as a grain of salt.

------
breck
A dumb question I've always had: for their S&P 500 Fund, is Vanguard just
free-riding off the work of S&P, leading to their low management fees? Or is
the work that goes into selecting the 500 companies in the index pretty
minimal?

~~~
readams
The S&P 500 is just a list of the largest 500 companies by market cap.

Managing the S&P 500 fund is actually pretty tricky since everyone knows when
the index changes and they know what trades you have to make so they try to
take money from you. You have to employ a lot of tricks to avoid being
victimized as an index fund.

Edit: I should point out that the index isn't really _just_ the largest 500
companies; they try to keep it properly weighted by sector and some other
considerations as well.

~~~
pbang
Do you mind elaborating on that point? I'm interested in hearing more

~~~
bluGill
When S&P announces results of the S&P 500 it is for fictional stocks: they
don't have a fund of their own. They just say that if had bought these 500
stocks in 1957, and traced only on the dates that the dates/prices the index
did you would have so much. This is impossible to do though (expect for the
smallest investors), the very act of trading a stock changes the price. Most
mutual funds have enough stock that they have to consider the effect of their
trade on the price of the stock: if they want to invest in a company it is
done over weeks and months to ensure the price doesn't change just as a result
of their actions.

A simple example: lets say company X and Y are both on the index and they
decide to merge one company X on such an such a date. In order to keep 500
stocks in the index S&P has to choose something to replacement. You don't have
to be very smart to see that X and Y are in talks about merging months in
advance. It isn't hard to figure that the stock S&P chooses will be one of a
few: Buy a bunch of them each at today's prices. When the merge happens all
those index funds now buy the replacement stock which drives the price up, you
have shares at an inflated price to sell to those funds. (You have figure out
when to sell the stocks that were not added - but S&P is unlikely to add a bad
stock so as an investment these are likely to do okay). This is easy if the
index funds try to hold exactly what the S&P 500 has in it.

Because of the above index funds promise to mirror the S&P500 results, but not
the actual stocks. It is easy to say mirror results, it is much harder to pull
that off, even if we ignore those above who are trying to cheat you, index
funds tend to be the largest funds (because they do so well they are popular!)
which means most of your trades will affect the price of the stock.

There is a lot more involved (much of it that I don't know), but the above is
a simple example that will get you on the right track of thinking.

~~~
kgwgk
But you can trade at the closing price, which is the one used by S&P to do
their numbers, can't you?

~~~
readams
No you can't. You can only buy a stock based on the set of offers to sell that
stock. The closing price is the just the price that marked the last trade of
the day, and isn't otherwise special.

~~~
chollida1
Of course you can buy at the closing price. There are MOC and LOC orders for
doing just that (Market On Close and Limit On Close).

The former indicates that you must get your order filled at the closing price,
the latter allows you to specify a limit at which you'll go to, in order to
trade at the closing price.

How else would funds that need to trade at the closing price, actually trade
at the closing price?

Now you may not like the closing price, but that's another story.

> The closing price is the just the price that marked the last trade of the
> day, and isn't otherwise special.

I guess i should also point out that many ETF's mark their value based on the
closing prices of the NYSE or Nasdaq making their closing prices very
important.

~~~
readams
Those are still just ordinary trades that happen at the end of the day. You're
still just pulling orders off of the queue of sell orders if you're buying.
The final close price will of course be the price after these trades are
executed, and you aren't guaranteed to even get the close price.

~~~
chollida1
> Those are still just ordinary trades that happen at the end of the day.
> You're still just pulling orders off of the queue of sell orders if you're
> buying. The final close price will of course be the price after these trades
> are executed, and you aren't guaranteed to even get the close price.

I'm pretty sure at this point I'm being trolled but just in case you are being
serious and don't know how to google......

[https://www.nyse.com/markets/nyse-
arca/auctions](https://www.nyse.com/markets/nyse-arca/auctions)

~~~
readams
Are you disputing that if you issue such a trade that you are not guaranteed
to be able to execute it? Because, I assure you, there is no such guarantee.
I'm not even sure why this requires some special explanation. There have to be
enough people willing to trade at that price. The exchange isn't going to
force people to trade with you.

~~~
chollida1
hold on, let me have some time to adjust for all the goal post moves you've
done here.

> No you can't. You can only buy a stock based on the set of offers to sell
> that stock

First you said that you can't buy/sell at the closing price and I showed you
that this is wrong. Infact there are a whole lot of people who are obligated
to trade at the closing price

Then you said the closing price wasn't special. This as well was shown to be
false as many ETF's are marked by the closing prices of certain markets,
notably the NYSE.

Then you said you aren't guaranteed to get the closing price. This was an even
stranger error as the message before I showed you the MOC order which
indicates that you will trade at the closing price.

Finally you tripled down on this mistake by changing your argument that
technically there might not be any trading partner at the close.

This is technically true that in theory it might happen, but in practice I'll
sit and wait for you to find me a case where this happened.

I mean think about it. You put out an MOC order that indicates you need to get
a buy order filled. Unless you are trying to buy some crazy amount of shares,
you will get filled. depending on the price the closing price can move up to
10% or 20%. This means that an arbitrager can pick up shares on the cheap or
sell them for an artificially high price.

The system just works.

I get that you don't work in finance but you continue to keep making the same
false statements over and over again:(

~~~
stouset
You're being intentionally obtuse, for what, internet points?

> kgwgk: But you can trade at the closing price, which is the one used by S&P
> to do their numbers, can't you?

> readams: No you can't. You can only buy a stock based on the set of offers
> to sell that stock

readams is unequivocally correct here. You can _attempt_ to trade at the
closing price, but doing so is entirely at the mercy of whether or not enough
open offers exist to sell that stock.

> chollida1: Then you said the closing price wasn't special. This as well was
> shown to be false as many ETF's are marked by the closing prices of certain
> markets, notably the NYSE.

This point by readams is also true. The closing price of a stock _isn 't_
special — it's, as (s)he said, simply the price of the last trade of the day.
The fact that some ETFs are marked by the price of market close makes _their_
trading price "special", but that doesn't imply anything particular about the
closing price of the asset(s) they're based on.

> chollida1: Then you said you aren't guaranteed to get the closing price.
> This was an even stranger error as the message before I showed you the MOC
> order which indicates that you will trade at the closing price.

Again, readams is correct. You're guaranteed to get the closing price _if and
only if_ there are open orders at that price. Which is a big if and only if,
and not actually a guarantee.

> chollida1: Finally you tripled down on this mistake by changing your
> argument that technically there might not be any trading partner at the
> close. This is technically true that in theory it might happen, but in
> practice I'll sit and wait for you to find me a case where this happened.

Consider the context of this entire conversation: index funds that manage
billions in assets. If you don't think they can utterly exhaust open buy/sell
orders at market close for any trade they need to execute to track their
index, you've lost your mind. This whole thread was about how these funds have
to strategically place their orders to track the underlying index as
faithfully as possible, without losing their shirts to vultures who know that
large funds have to execute certain orders to stay on track.

~~~
toast0
> This point by readams is also true. The closing price of a stock isn't
> special — it's, as (s)he said, simply the price of the last trade of the
> day. The fact that some ETFs are marked by the price of market close makes
> their trading price "special", but that doesn't imply anything particular
> about the closing price of the asset(s) they're based on

The closing price is special -- there's a special procedure to set the price
and determine which orders execute (quite similar to the opening procedure),
NYSE has a closing auction, NASDAQ has a closing cross, I'm sure most other
exchanges have similar.

If there's no market/limit on close orders for a given stock, then the closing
price would be the last trade; presumably the same for a stock which had its
trading halted earlier in the day.

~~~
kgwgk
I think this paper is interesting: [https://mrtopstep.com/wp-
content/uploads/2016/02/ITG-Trading...](https://mrtopstep.com/wp-
content/uploads/2016/02/ITG-Trading-Around-The-Close-11-7-2012-1.pdf)

~~~
anonymousDan
Indeed it is, thanks for posting. It always surprises me how when you get down
to the nitty gritty of how financial markets work there is a lot of hidden
complexity to the mechanics that could have a significant affect on how you
should trade.

------
baccredited
Fun fact: Save 70% of your income and use it to buy ticker VOO (Vanguard's S&P
500 fund) and you can retire in under 10 years

[http://www.mrmoneymustache.com/2012/01/13/the-shockingly-
sim...](http://www.mrmoneymustache.com/2012/01/13/the-shockingly-simple-math-
behind-early-retirement/)

~~~
fibbery
And if the S&P drops like it did in 1987, 2000, 2008, then what...?

~~~
RestlessMind
Then just wait for a few years and it will recover again.
[https://www.google.com/finance?q=INDEXSP:.INX](https://www.google.com/finance?q=INDEXSP:.INX)

~~~
apr
Who will pay the bills in the meantime?

------
ms207
This is what happens when some companies project investing as a quick and
slick process. Answer these 5 questions and here you go: this is your risk
tolerance and you are saving away in taxes and doing rebalancing. The truth is
that investing is just another application to data science and machine
learning and a lot of hard work. Little things matter and even simple
rebalancing is not as simple given that periodic rebalancing can have huge
market timing effects. We recently did a webinar on how to approach investing
as a data science problem instead of a 'finance' problem:
[https://www.qplum.co/webinars/past/07072016/skill-vs-
luck](https://www.qplum.co/webinars/past/07072016/skill-vs-luck)

~~~
gauravchak
A friend of mine invested in two roboadvisors (wealthfront and betterment) at
end of April and since then they have done nothing, not a single trade. Not a
single trade. In the mean while, markets have scaled new heights. Ten year
rate dropped to 1.37%!. Brexit happened. The FED unlike happened. There were
huge gyrations in the unemployment rate. Vanguard systematic fund VMNVX did
much better. I have worked in trading all my work life and I know how hard it
is, how humbling it is, and how meaningful it is. I hate it when people sell
crap as smart. As Dean Kansky in Serendipity said "They should make pills for
this."

------
nstj
I really look forward to the day when it's easy (and safe) to have API's at
places like Vanguard so developers skilled in areas such as UX can layer
technology solutions on top of the fantastic investment products provided by
outfits like Vanguard.

~~~
hsitz
I don't see much benefit. The investment philosophy that goes along with
Vanguard is buy-and-hold for the long term, there's little trading that goes
on these accounts. And that's a good thing. It's not like it's difficult to
trade stocks as it is, no real need to make it easier.

~~~
nstj
I'm thinking more about harnessing insight into the returns on the products
themselves (and of course not using an API to trade, that wouldn't make much
sense with an index fund).

------
oli5679
Several of the comments seem confused about why the process isn't entirely
straightforward. Here's an example:

Say I have $100 mn under management at an index fund.

When the markets close on Thursday, I have a 5 mn weighting in Apple and its
market capitalisation is equal to 5% of the S & P 500 index.

On Friday morning, Tim Cooke makes an inspiring speech about the iCar and
Apple's market cap rises to 8% of of the S & P index.

I want to sell some of my other positions and buy Apple so that I still have a
balanced weighting of S & P 500 shares. However, I face a tradeoff.

If I do this in small bursts over the course of the day, I have a higher
administrative burden. I also risk running up bigger transaction fees if Elon
Musk makes another speech in the afternoon unveiling the Tesla-phone, forcing
me to sell again after Apple falls back down to 5%.

If I wait until 3.59 to place a massive sell order for all my other stocks and
buy order for Apple, (a) market participants might think I know something
about Apple, causing the price to rise yet further as I struggle to complete
my order (b) sneaky traders could buy up Apple Stock at 3.55 and then sell to
me at 3.59 for a higher price.

This is the balancing act a passive fund manager faces.

Edit:

As comments point out, this example is incorrect. First example should say
something like Apple splitting into Apple and iPhone and then the relative
prices changing after the split. The second half still makes sense.

~~~
Hermel
This example does not work. If Apple raises from 5% to 8% of the SP500, it
also raises from 5% to 8% of your portfolio. No rebalancing is needed when
weighting stocks by market cap.

~~~
anonu
That's correct. A passive index manager is passive - they don't have to worry
about some balancing act. It differs from active management because the
manager isn't making decisions about which stocks are in the fund. Where the
passive fund manager has to do work is on index rebalances and on any
constituent corporate action.

------
peterwwillis

      O’Reilly [..] came to the U.S. in 1983 to attend Villanova University
      on a track scholarship. As a junior, he ran the mile in less than four minutes
      —a feat he repeated six times. He led Villanova to a conference championship 
      and represented Ireland at the 1988 Summer Olympics in Seoul.
      
      A few years later, O’Reilly joined Vanguard.
    

That's the story I would have rather read.

------
notadoc
And what happens when nearly everyone indexes?

And when indexing with a bond fund, do you really want to be buying negative
yield bonds?

~~~
Spooky23
With interest rates on the floor, why would you want any bond index fund?

You're better off putting your bond allocation in high yield savings accounts.

That's the thing about index/robo people that I don't get. The magic formula
can do dumb things.

~~~
refurb
Because bond prices move in the opposite direction of equities (generally)?
Also, you're not just collecting interest off those bonds since prices move
based on the market's interpretation as to where future interest rates are
going. I'm sure my explanation sucks, but if the economy starts to improve,
the expectation is that rate will go up, so bond prices fall. And the inverse.

Take a look at Vanguard's bond fund (BND). It went from $80.5 to $84 since
January 2016. That's a 4.3% return over 8 months and it wasn't because of the
interest the bonds pay. It was also at ~$84 back in 2013. As the economy
improved the price dropped then went back up again.

Basically, bonds provide a way to diversify to an asset that is not correlated
with equities. Investing in bonds reduces your overall return (vs. just
equities), but it also reduces the risk level. If you find that sweet spot you
can optimize for slightly reduced returns at a much lower risk. This is
standard Boglehead theory.

Folks who know more than me can correct my explanation.

------
lintiness
a single company managing that big a share of the available float worries me
-- not from some paranoid, political angle, but from an error and risk
standpoint.

~~~
kevindkeogh
there is a lot of market infrastructure and jurisprudence that exists
specifically for this problem. Trades can and are canceled as the situation
demands[0].

[0]
[https://www.theice.com/publicdocs/endex/ICE_Endex_Trade_Canc...](https://www.theice.com/publicdocs/endex/ICE_Endex_Trade_Cancellations_Price_Adjustment.pdf)

~~~
lintiness
tell that to knight ...

------
d310n9
when the corner shoe boy gives you stock advice, its time to get the hell
outta there!

------
jflowers45
I'm probably being persnickety, but I think the title here on HN is mildly
misleading, as he is actually named and the actual title of the Bloomberg
article calls him "Basically Anonymous" ... not actually anonymous

~~~
ISL
I'd probably change Anonymous to 'Little-known'. Anonymous would suggest that
nobody has any idea who is managing the money...

------
ape4
There isn't much to manage since they are index funds.

(Edit: Ok, I'll accept the downvotes. I mean not _as_ _much_ work as other
fund managers. eg don't have to select companies to invest in.)

~~~
Spoom
This was covered in the article:

 _Vanguard has invested heavily in technology. Algorithms help managers figure
out where to buy and sell while minimizing market impact. Risk software makes
sure the portfolio stays close to the index. Because of these technologies,
Brennan says, “we probably have the most assets per head of any asset manager
in the world.” (The key determinant of staffing, he says, is the number of
portfolios, not the assets in them.)

But you can automate only so much, and the tough decisions still fall to the
portfolio managers. When is the best time to buy an illiquid stock that trades
only once or twice a day? How do you handle a corporate deal structured in an
unusual way or the issuing of a new class of stock?

“People think a computer could run index funds­—and they’re so wrong,” says
Brian Bruce, a former index fund manager who’s now chief executive officer of
Hillcrest Asset Management in Plano, Texas, and editor-in-chief of the Journal
of Index Investing._

