
Is Passive Investment Actively Hurting the Economy? - JacobAldridge
http://www.newyorker.com/business/currency/is-passive-investment-actively-hurting-the-economy
======
JoshTriplett
Is it just me, or has there been a series of articles specifically putting
Vanguard in the crosshairs lately? Between this and the ridiculous attempt to
blame Vanguard for being too efficient and charging _too little_ in overhead,
I'm starting to wonder if there's a specific campaign going on here.

Vanguard is definitely at the forefront of advocating "just put your money in
an index fund and wait, don't try to time the market". There's a huge amount
of money behind the alternative that will suffer if more people follow that
advice. Media campaigns are, on that scale, relatively inexpensive.

~~~
hkmurakami
Matt Levine has a pretty balanced perspective on the matter:
[http://www.bloombergview.com/articles/2015-07-22/index-
funds...](http://www.bloombergview.com/articles/2015-07-22/index-funds-may-
work-a-little-too-well)

His opinion iirc is that at some point there will be an inflection point where
there will once again be profits to be had through information discovery, and
the two forces will balance out.

~~~
JoshTriplett
There are always profits, and losses, to be had through attempting to beat the
market. The trick is whether anyone can _consistently_ beat the market, time
and time again, such that their long-term return reliably exceeds that of the
market itself.

For that, I'd refer to [http://longbets.org/362/](http://longbets.org/362/) .

~~~
n72
The point is is that it becomes easier to beat the market the more people are
indexing. Thus there become more people consistently beating the market.
Identification of such is still an issue, but not as difficult.

~~~
tosseraccount
How Many Mutual Funds Routinely Rout the Market?

zero.

 _" Look more closely at those gaudy returns, however, and you may see
something startling. The truth is that very few professional investors have
actually managed to outperform the rising market consistently over those
years. In fact, based on the updated findings and definitions of a particular
study, it appears that no mutual fund managers have."_

[http://www.nytimes.com/2015/03/15/your-money/how-many-
mutual...](http://www.nytimes.com/2015/03/15/your-money/how-many-mutual-funds-
routinely-rout-the-market-zero.html)

~~~
hkmurakami
At this point, Mutual Funds are the bottom of the barrel with respect to
attracting talent for active management. There are plenty of examples of
active funds that have consistently beat the market.

ex: _Since Horseman 's inception in February 2001, the fund has achieved
annualized returns of 14.79%, according to HSBC._

[http://www.bloomberg.com/news/articles/2016-01-06/horseman-c...](http://www.bloomberg.com/news/articles/2016-01-06/horseman-
clark-s-love-of-losers-powers-20-gain-in-hedge-fund)

~~~
tosseraccount
This fund?
[https://hedgefundranks.com/fund/909](https://hedgefundranks.com/fund/909)

~~~
hkmurakami
seems to match up.

[http://www.zerohedge.com/sites/default/files/images/user5/im...](http://www.zerohedge.com/sites/default/files/images/user5/imageroot/2016/01/horseman%202.jpg)

------
nostrademons
It's a self-correcting problem: as more investors place money in passive
funds, fewer eyeballs look for opportunities where the consensus price is
_wrong_. That means that there's less competition for these opportunities,
which both increases your chances of finding them and increases the returns to
finding them. Eventually, active investing becomes fashionable again, because
the returns are real and measurably higher, and the cycle repeats.

It may be contributing to greater wealth inequality, though: if you look at
basically anyone who has become fabulously wealthy in the last couple decades,
it's because they saw a profit opportunity that others were unwilling or
unable to exploit. The primary form of unwillingness is "It's too risky..."

~~~
foobarqux
The fear is that prices won't correct because passive investors _are_ the
market. Also, there may not be anyone to take the other side of a trade
because passive investors don't trade very often.

~~~
nostrademons
That just creates the conditions that lead to Warren Buffett's rise: a
conservative market that often wildly mispriced securities. And you can trade
against it the same way Mr. Buffett did: identify underpriced securities and
buy & hold them until the market realizes their value, or if the market
_never_ realizes it, just end up owning a large fraction of American business
and reinvest the profits from it.

Usually, once it's become apparent that some people are getting fabulously
wealthy by breaking away from the herd, jealousy and Dunning-Krueger take over
and you get a large number of people that are suddenly true believers in
active investing.

~~~
foobarqux
The counterarguments, which I don't find super compelling but are nonetheless
pretty reasonable, are

1\. You may not even be able to acquire shares or to dispose of them (everyone
is passive!)

2\. Low liquidity + required multiyear holding times = dramatically increased
risk

3\. Businesses are affected by the markets their shares trade in. Earnings can
be depressed by increased costs of capital, sentiment and anti-competitive
pressures from shareholders who hold the entire market.

~~~
marcosdumay
The first one isn't even a real argument. That is claiming new initiatives
just won't happen - if you stop being passive for exploiting this new market,
not everyone is passive anymore. And about disposing, well, this is where the
profits come into.

The third is mildly concerning. If a few companies are swimming in money, they
may disturb every market around. Historically this don't last for long, every
time the market gets like this, there comes a crisis and destroys those big
players. Worth keeping an eye to a "this time is different" event.

Now, the second one is the real problem here.

------
cesarbs
Critics of index investing always overlook the fact that there are many
different indexes out there. The criticism always hypothesizes that everyone
will put their money in an S&P 500 or a total stock market fund, while the
reality is that indexers do all sorts of slicing and dicing with their index
funds.

By reading just a few posts at the bogleheads.org forum one will quickly see
that a ton of people overweight small caps and value stocks (and often the
combination of those two factors, small cap value stocks). Some use an S&P 500
index, some use total market. Some hold international indexes (in their
different flavors too - developed markets, emerging markets, total intl
market, intl value stocks, etc.). Some overweight REITs in their portfolios.
The combinations are infinite.

I personally believe that even if everyone indexes we'd still see significant
activity in the market because not everyone indexes the same way. Also, a lot
of indexers like to dedicate a portion of their portfolios to active investing
once they reach a certain net worth - I myself plan on doing so.

The bottomline is that criticisms of indexing are either made out of ignorance
or fear, or they have an ulterior motive behind them (such as promoting a
firm's actively managed mutual funds).

------
omegaworks
Seriously? First you get rid of pensions and force young workers into private
retirement funds and now you want to eviscerate the one fund that actually has
it in its mission statement not to fleece its members for all that they have.

Tell it like it is. The private retirement system was rigged to begin with,
with sole purpose to line the big banks' pockets with management overhead
uncorrelated to the performance of the funds.

Quote Goldman Sachs more. Let's see how seriously your source holds up the
next time they orchestrate the collapse of the global economy and come to the
taxpayers for handouts.

------
makomk
> banks whose shares are often packaged in index funds tend to offer higher
> fees and rates for such services as account maintenance and deposit
> certificates than banks whose stocks are rarely or never included in index
> funds

Obvious explanation: the banks packaged in index funds are the largest banks.
People don't tend to switch banks all that often, so larger banks charge
larger fees to take advantage of their existing customers whilst smaller banks
offer better deals to get customers. The explanation in the article makes no
sense; it's in shareholders' interest that the banks they own shares in make
as much money from customers as possible. (Also, since either outcome could be
used to justify their conclusion, this is not science.)

~~~
eru
The article quotes a scientific paper. Chances are better than even that the
paper controls for something as obvious as size.

To the articles credit, they linked the study they are talking about. I am
still downloading the pdf, so can't say anything concrete yet.

------
late2part
There's a larger context here - the dearth of owner-operators. Perhaps Google
and Facebook are exceptions, but the mind-numbing risk avoidance and Wall
Street cadence quarterly earnings mentality are not always good.

~~~
danieltillett
Capitalism without capitalists, only rent seekers.

------
maerF0x0
This author shows little knowledge of how the stock market actually works:

> A market with more passive investors than active ones will continue to push
> money into the largest firms, whether these companies are actually
> performing strongly or not.

When I buy an index fund holding the S&P 500, none of those businesses get my
money, My money does not go into any of them. I have bought an already
existing asset from another person who is selling it.

~~~
finance-geek
At a primary level, you are correct. But the effects of passive investment are
more subtle. 1\. More investment dollars chasing big companies allows those
companies to issue more stock without having to worry about pushing prices
down (since there is this extra upward pressure of increased flow.) 2\.
Increased stock prices from increased flow gives the company more stock value
for acquisitions 3\. If money keeps flowing into particular stocks, it
encourages companies to be lax about dividend growth, since the prices rise
regardless.

~~~
maerF0x0
Those are subtle and interesting points.

------
blacksqr
It's the worst possible investing method except for all the others.

If anyone could come up with a method that consistently beat passive
investing, the situation would change in a heartbeat.

~~~
bunderbunder
Would it? Or would the discoverer of the method be more inclined to keep the
knowledge to themselves in order to maximize their own potential profits?

The thing about competitive edges is, if you share them with everyone else
then that causes them to disappear.

~~~
blacksqr
Well, the discoverers of passive investing didn't keep it to themselves, and
now they're making lots and lots of money running index mutual funds.

------
prostoalex
All excellent points. As a random company moves from being active-investor-
owned to passive-index-find-owned, what corporate governance mechanisms are
there in place as far as board structure and management compensation? Feels
like the management is getting a blank check with no one else being in charge.

~~~
justin66
It would be nifty if there were a proxy mechanism whereby index fund
shareholders could vote their underlying shares. It's technologically
feasible, I have no idea if there are any legal hurdles, or if it's simply
something no funds have bothered to implement yet.

~~~
mooreds
The issue here is that in order to intelligently vote such shares, passive
investors would need to invest time and effort to understand how board members
voted, what their interests were, etc. What percentage of passive investors
are going to make that kind of effort?

~~~
eru
They could also rent out the voting rights to the highest bidder. (Just like
you can already rent out your shares to shorters.)

------
erikpukinskis
I feel like targeted index funds solve this problem. People make coarser
judgements about what "the market" actually means and which markets they
actually want to buy into... It's sort of semi-passive. You make decisions on
the timescale of financial strategy sessions, which is fine.... You can be an
infrequent signal, as long as you are a rational signal you are good for the
economy.

------
ftwynn
I'm sure there are some legitimate points to be made on this front (indexing
methods and such), but this piece reads to me like a giant justification for
active brokers and their fees.

> But perhaps we shouldn’t be shocked if an investment method that encourages
> us to use as little discernment as possible ends up being too good to be
> true.

... are we just not going to mention that no one beats the market forever, so
the intentionally simple, though counter-intuitive, decision might be the
right one?

------
gersh
According to the author, the passive investors are buying into indexes
regardless of valuation. However, we know the private unicorns have gotten
higher valuations than public companies, which is the opposite of what we'd
expect. Further, real estate prices have been going up, and real estate is not
a passive investment.

~~~
walshemj
is there not an ETF that is index on property companies ?

~~~
kasey_junk
Look into REITs.

~~~
gersh
Yes, but how much of real estate is owned by REIT?

------
yason
Passive investment probably hurts the economy of active investment business.

------
AnthonyMouse
It seems like funds like this would be relatively predictable in what and when
they buy and sell. If they're doing it at a large enough scale and you can
predict it ahead of time...

~~~
eru
People already play this game. Enough people to compete away the profits to be
made serving the index funds with market making.

------
simo7
The argument makes sense.

Yet, if so, we should see unreasonably high PEs for big companies
(particularly the ones in the Dow).

Why isn't that the case?

------
lingben
here's a good counter point:

[http://www.pragcap.com/passive-investing-isnt-hurting-the-
ec...](http://www.pragcap.com/passive-investing-isnt-hurting-the-economy/)

------
Marazan
No

------
daodedickinson
I'm glad people are starting to realize that the moral hazard with index funds
is far larger than the moral hazard at the core of the last recession.
Everyone goes into index funds expecting somebody else to do the homework, so
the few quants actually doing homework increasingly figure out how to make
money at the expense of the market instead of in a way that boosts the market
as a whole.

~~~
saryant
What "homework"? It's an index based on market cap.

------
mudil
Everything has two sides. We are going to see the other side of ETFs one day.
And it is not going to be pretty. I read an article in WSJ over last weekend
about problems with Blackrock gold ETF that was suspended. Apparently some
believe that etfs can get in big troubles one day. They can have either
liquidity issues or crash significantly more than their underlying securities.
There could be a run.
[http://www.bloomberg.com/news/articles/2016-03-07/blackrock-...](http://www.bloomberg.com/news/articles/2016-03-07/blackrock-
resumes-issuing-gold-etf-shares-after-suspension) Not first time. This was
last year: [http://www.barrons.com/articles/the-great-etf-debacle-
explai...](http://www.barrons.com/articles/the-great-etf-debacle-
explained-1441434195)

------
seibelj
Once everyone and their grandmother started investing in index funds, I knew
it was time to pull out. I do Greenblatt's magic formula [0] strategy now,
it's doing pretty well even in this down market.

[0]
[https://en.wikipedia.org/wiki/Magic_formula_investing](https://en.wikipedia.org/wiki/Magic_formula_investing)

~~~
eru
You know, they have index funds that do value investing?

