
The Financial Industry Is Having Its Napster Moment - T-A
http://www.bloomberg.com/news/articles/2016-04-07/the-financial-industry-is-having-its-napster-moment
======
chollida1
I kind of get the sense that perhaps some people are upvoting this article
because of the title and they just agree with the sentiment. Which is fine but
I don't really think this article is saying anything new here.

Actively managed mutual funds are going away fast and that's to everyone's
benefit. Some were charging 2% yearly plus a fee when you bought or when you
sold( redemption fees). I can't think of a single reason that anyone should
have any money in an actively managed mutual fund.

If there is a continuum of hedge funds to ETF's, actively managed mutual funds
are literary the worst of both worlds. High fees and low ability to make
returns.

From where I sit, the biggest jobs that are in danger are sales jobs. There
used to be teams of people at mutual fund companies whose sole job was to sell
their products to Investment advisers at brokerages with the hopes that the
advisor would put their clients money into these funds.

As someone who is on the side of actively managing money, I see this as a
strong positive. The more passive money there is sloshing around the more arb
opportunities there are!

~~~
vchynarov
Generally I agree with you. However I can provide a personal counter-example.
I am a student with a modest sum saved away (with great help from my parents)
in an index tracking mutual fund. Due to the way my bank offers investment
packages, I am far below the minimum portfolio balance required for
significantly less fees. However, I can have a mutual fund in a different type
of account offering which is essentially the same as an identical ETF.

This is (Canadian) RBC - Direct Investing.

In addition this particular fund also significantly outperformed other ETFs
during 2008-09.

~~~
aianus
Questrade in Canada lets you buy ETFs for free, as little as one share at a
time. You only pay when you sell ($0.01 a share, minimum $5 a trade).

Anything sold by the big banks in Canada is almost always a ridiculous rip-
off.

Even better might be something like Wealthsimple.

(Not affiliated with either company except as a customer)

~~~
mabbo
Friend of mine work over at WealthSimple. Glad to hear people like it.

------
optimusclimb
Why are actively managed funds paid via fees, and not based on performance?

If someone (or some company) is claiming to be better than me at using my
money to make money, surely they'd agree to put skin in the game, and only
profit when I do?

If they don't feel confident enough about their choices making money (and
hence, ensuring they get compensated), why should I?

edit: I was referring to the types of funds typical retail investors are in,
not hedge funds.

~~~
jzwinck
> If someone (or some company) is claiming to be better than me at using my
> money to make money, surely they'd agree to put skin in the game, and only
> profit when I do?

Imagine you believe that mail order companies are poised for rapid growth in
coming years. You don't know which ones specifically, and there are thousands.
So you buy a mutual fund which holds hundreds of these companies. This gives
you some diversification and lets you make your bet with only a single
commission to buy and sell.

But the fund manager may disagree with your investment thesis. She may be
fully convinced that online shopping has already destroyed the mail order
business permanently. She would therefore gladly run a fund for you, but she
would not bet on its performance herself.

For a somewhat more real-life example of this, watch or read "The Big Short."
The protagonist wants to buy something that the banks think will lose money.

~~~
optimusclimb
> But the fund manager may disagree with your investment thesis.

I'm referring to funds managed for me with the proposition that they will beat
the market, i.e. the fund manager has a thesis which they agree with (because
it is theirs.)

So while what you're referring to of course exists, it's not what I was
talking about.

Apologies for being too vague in my post, however I thought the underlying
assumption of this discussion of actively managed funds being chipped away by
passive ones was that we were talking about the types of investment vehicles
used by a "normal" person that wants to put their money in something that will
grow over time, without having to pick stocks on their own.

~~~
jzwinck
This normal person who has no strategy at all had better just buy a broad
index fund. It's made for them!

If a person's only belief in the market is that they want to beat it, they are
out of luck before the opening bell.

------
minikites
Since learning about the concept of the Baltimore Stockbroker, I'm thinking
that actively managed funds as a concept are horseshit.

[http://www.theguardian.com/books/2014/jun/13/how-not-to-
be-w...](http://www.theguardian.com/books/2014/jun/13/how-not-to-be-wrong-
hidden-maths-jordan-ellenberg-review)

>Here's a cautionary tale. A broker sends you 10 free stockmarket predictions
in a row that all come true, and then asks for money for an 11th. The
stockbroker's offer seems reasonable enough. His strike rate is 10 out of 10,
so surely he will be right the next time, too? Don't do it! If you pay for the
11th tip, you will have fallen victim to the oldest scam in the book. Unknown
to you, the stockbroker has been sending every combination of possible
predictions to tens of thousands of other people, and you are one of the
unlucky few who got 10 good ones in a row.

>Imagine you are considering investing in a mutual fund. Before funds are
opened up to the public, they are often monitored in-house. Funds that don't
perform well can be shut down, without the public ever knowing. Ellenberg
warns that if you are seduced by funds with an eye-popping rate of return,
then you are walking into the Baltimore stockbroker's trap: "You've been
swayed by the impressive results, but you don't know how many chances the
broker had to get those results."

------
wodenokoto
I read that it is fairly easy to guess which companies will move in and out of
S&P 500 and similar indexes, and since a larger and larger part of the market
now sits in passive funds it is easy to predict large movements in buy and
sell around when these indexes are updated.

So that should definitely open up some opportunities to beat the passive
funds.

~~~
HappyTypist
Not really, the big index fund providers are smart and they even pre emptively
buy companies likely to be added to the index, and they sometimes wait a bit
before rebalancing to their index. This intentional randomness makes it very
difficult to front run index funds.

~~~
SilasX
Isn't that, itself, a species of active management?

~~~
arielweisberg
It could be construed as such. Really it's all about execution strategy.

If your concern is that it's active you can always check to see how well the
fund tracks the index. The reality is that they track the indexes so well that
it doesn't matter. At least for total market or S&P 500 funds.

There are problematic indexes that don't seem to get tracked well by funds.

------
tma-1
I am not very cheerful about the markets being "-largely driven by passive
investors. Traditional investors play a pivotal role in corporate governance
and strategy, and reward management with a track record. Unfortunately the
flows are becoming more and more driven by passive strategies, and this can
potentially lead to negative externalities in the economy [1].

[1]
[http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2663398](http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2663398)

~~~
jeremyt
I don't think that you have any reason to worry. Once everybody is using index
funds, there will be plenty of opportunities for actively managed profits, and
people will begin to take advantage of it again.

~~~
seansmccullough
I think you're right, if a large portion of a company's stock is owned by
passive funds, there should be some arbitrage opportunities since the funds
won't buy or sell based on the company's fundamentals.

------
brownbat
Diversification is good for individual investors, but it's also a good way for
an economy, or for a financial sector to hedge against systemic risks.

So if ETFs are taking over, it may be an improvement overall, but it's worth
thinking through the black swans, the new low probability high impact risks
that this creates.

Bloomberg has had a few comments about liquidity risks for ETFs on their site
and in the Odd Lots podcast.[0] On the other hand, they've made these comments
for a few years now, so maybe this is a chicken little story. Or maybe it only
kicks in under certain conditions, like if we saw interest rates, demand for
goods, and inflation spike, people start moving to other investments,
potentially causing a sudden run on funds that are stuck holding only bonds
without any real returns or way to offload them?

[0] [http://www.bloomberg.com/news/articles/2014-09-23/etf-
liquid...](http://www.bloomberg.com/news/articles/2014-09-23/etf-liquidity-
risk-a-concern-for-regulators-wilkins)

~~~
x5n1
So invest in a black swan fund.

~~~
brownbat
Black swan funds have been doing neat things. But I didn't mean to imply I'm
concerned about this as an individual investor.

I'm honestly not that concerned about it at all, because it seems like an
unlikely problem. But to whatever extent I am, the question wouldn't be "how
do I protect my own investments?" It would be, "how should we protect all the
retirement savings across the country that are placed under passive management
automatically?"

To really answer that question though, we'd probably have to know the actual
level of risk and the timing of any crisis, which aren't trivial questions.

------
p4wnc6
I think this is pretty naive. Customers (generally large institutional
investors) don't choose active managers because those managers provide
superior returns. They choose them for the same reason that people choose big
consulting firms like BCG or McKinsey: status and affiliation, nepotism,
internal power struggles, and cover-your-ass blame insurance.

I mentioned in a previous thread about this -- I worked for several years in
an asset management firm before moving on to other things. We frequently
assisted clients in the process of firing us. We would prepare white papers
for them, give them data and slick charts. Sometimes this would literally
disrupt the quants and research team and we had to join in creating materials
that would be used by client board members in their presentation of the
decision to fire us. Sometimes we even had to provide examples of this kind of
work when a client was _hiring us_ \-- our helpfulness and data services
_during the times when we are fired_ was actually a prominent selling point.
We were basically saying, hire us now and you get to look fancy. Fire us later
and we'll set you up to look principled and full of conviction to do the right
thing as a sophisticated board member.

There are all kinds of laws restricting gifts you can give to clients or
receive from clients, and just as many stories about how such-and-such a
client took some regional sales manager out to a strip club, or flew them some
place and got them a reservation at some exclusive restaurant or something.

It's all political. As a technical person, you are hired to look fancy on
paper. I remember overhearing my boss bragging to a prospective client that
the team had an "Ivy League graduate" leading up their quantitative software
development ... on my _second_ day of work! I had zero financial experience of
any kind at the time. It was ludicrous.

It's painful to see everyone buying into this. I hope beyond all hope that
clients do a better job of actually holding firms responsible for returns.
Firms that don't engage in legitimate statistical research to determine an
edge in investing will fold up, and firms that actually have a chance at
superior returns might actually start letting their staff do real research
work instead of bullshit marketing and catering to client political whims.

But that's a fairy tale world. This will all blow over and clients will
continue dedicating huge blocks of their endowments or retirement funds to
active managers for political reasons and will continue happily _not_ holding
those managers accountable for inferior returns.

~~~
MakeUsersWant
> They choose them for the same reason that people choose big consulting firms
> like BCG or McKinsey: status and affiliation, nepotism, internal power
> struggles, and cover-your-ass blame insurance.

There must be some lean way to exploit that.

In theory, you could manufacture status for your consulting firm. (So that's
why BCG and McKinsey plaster German universities with their ads.)

~~~
p4wnc6
The barriers to entry in these kinds of status/credential fields are extremely
high. Starting a new asset management firm is extremely difficult, and no
customer is even going to talk to you until you have a five year track record
of performance and a ton of marketing machinery surrounding it.

Whether it's my grandma at the local bank or a huge endowment for a state
teacher's union, people still want a handshake and a white-toothed car
salesman smile when they hand over their money -- they want a false sense of
security even if they are knowingly complicit in its falseness.

Since you can't pop up overnight and start claiming "Hey, we've been around
for X years so trust us" it makes it very hard.

One exception is with small hedge funds that are created with a direct tie to
a wealthy individual. That's almost always how small hedge funds start and few
other types survive. Basically, there will be some semi-rich hot shot finance
types who want to start a hedge fund, and then they have to convince some
wealthy business contact, someone with usually > $100 MM in assets, who
doesn't mind fronting the significant costs to get a small strategy up and
running. Then, if it works, that wealthy person will effectively be the
marketing department for a while and will recruit other wealthy connections to
give somewhat small amounts of money, growing AUM slowly.

If you really succeed beyond the 5-8 year mark, then you can start trying to
tap into more traditional client streams.

But basically, without a close connection to a significantly wealthy person,
the status-based barriers to entry for things like management consulting and
asset management are just too high.

------
chvid
The financial industry (as a whole) is very very far from having its Napster
moment.

The industry has gotten much tighter regulated since the GFC giving the
incumbents an even stronger grip on their position.

And the specific low-cost index funds, the article is dealing with, have been
around for decades now. I really don't think the headline is called for.

------
dantiberian
Matt Levine has a great article on this, exploring the subject with a lot more
nuance
[http://www.bloombergview.com/articles/2016-04-07/fiduciaries...](http://www.bloombergview.com/articles/2016-04-07/fiduciaries-
reporters-and-inversions) (as always).

~~~
ttcbj
Thanks for that link, really helpful.

------
jheriko
tl;dr: the financial industry is distasteful.

i understand what is being said here. i don't think it is revelatory.

on the other hand this article just adds another small contribution to my
strong distaste for the practices of the financial industry overall.

investing money into funds to make more money seems great at first glance, but
once you dig into the details and realise the number of people involved taking
their cut, how many companies are effectively running off of weird loans
through 'ownership', and how many piles of assets are owned by people as a
mechanism to make more money... its all very distasteful to me. :(

then again, i don't like investment. i don't want it for my own company. it
looks like a way to become beholden to others and introduce a risk of spending
more money than you actually have.

------
willholloway
The more money that moves in to passive funds, the less efficient the market
becomes and the more opportunities for profit through active investment.

~~~
AndyMcConachie
Prove it.

Where there is a buck to be made, someone will make it. All this talk of index
funds ruining capitalism just sounds like a bunch of whiny fund managers not
getting their cut.

~~~
optimusclimb
I don't know about proving that the market will be "less efficient", as OP put
it, but certainly the rules would be quite different.

If 100% of retail investors were in "passively" managed funds, wouldn't that
just be saying there's a giant fund of money available, to be split among
public companies that meet certain criteria - and thus a set of concrete rules
to be gamed?

It would just be another input into the market equation. Investors could then
say, "I think the macro environment right now is going to lead to events X and
Y happening, which will in turn ruin these 5 companies, which will cause a
rebalance in the giant pool of passively managed fund money, and so I'm going
to make this bet that that happens."

------
JunkDNA
Didn't the Napster moment happen in the late 1970's when John Bogle started
Vanguard?

~~~
te0x
No, in context "Napster moment" is used to describe the effect on the
industry, especially when the revenues are moving. Even though Vanguard and
ETFs have been around, no one paid attention to them for decades.

------
elihu
I wonder if there's an opportunity for someone to come along and undercut the
passively managed ETFs and index funds? 0.10% is still a lot of money when
you're managing billions or trillions; is there any reason someone couldn't
come along and provide the same service for a 0.01% or 0.001% fee?

~~~
stouset
This seems implausible. A 0.01% fee on a $1bn fund equates to $100,000. This
isn't enough to pay a single full-time employee, not to mention to actually
conduct trades, perform accounting, and deal with legal/tax considerations.

~~~
d4rkph1b3r
You don't really need to make any more then that if you're front running your
own trades!

~~~
kasey_junk
Describe precisely how that works please.

------
clutchski
If index funds become the default investment of choice, will their value
diminish?

~~~
Phlarp
Short answer: yes, and already happening.

~~~
mr_luc
As an outsider, I'd love to read more about this.

~~~
cm2187
Basically if you are following the same publicly known strategy (buy the
index), other investors can arbitrage you by buying or selling ahead of you,
like before a stock becomes part of the S&P500. That means you always buy
stocks dearer and always sell cheaper.

That's why confidentiality and anonymity is crucial to a functioning market.

~~~
kdamken
If there any difference if people were to instead invest in a Total Market
index fund vs a S&P500 one?

~~~
cm2187
You dodge the arbitrage of stocks getting in and out of the index but you miss
the virtue on using an index, which is that the index rules are not a horrible
investment strategy: buy the stocks that are on the rise, sell when stocks are
on the way down.

But total markets will still have other downsides, like all the stocks become
completely correlated if enough people are only making investment decisions on
the total market instead of individual stocks, and prices become less
meaningful.

~~~
kdamken
Interesting - I've been saving money and trying to get into investing more
recently, and lots of the advice I've read for someone young seems to point
towards using an allocation of something like 90% stocks and 10% bonds, maybe
like

\- 55% Vanguard Total Market Index

\- 35% Vanguard Total Market International Index

\- 10% mixture of Vanguard bond domestic and international index funds

Is there a better strategy out there besides index funds that doesn't involve
me getting eaten alive with active fund fees? A lot of what I read suggests
that actively managed funds never consistently outperform the market index.

------
alistproducer2
The actively managed funds in my 401k are all underperforming the market. Why
pat a premium to lose money?

~~~
hibikir
The 401k situation especially egregious: Even good companies in the financial
business end up picking horrible choices for their 401k options. For instance,
my current employer has an SP500 index fund in their choices... with a 0.3%
fee! For comparison, Vanguard charges me 0.05% for tracking the same index,
for an enormous, nonsensical profit of the fund my employer picked. And that's
the cheapest one by far! Most options are active funds with 2% fees.

Nobody in their right mind would use funds like that if they bought them for
their own IRA, but 401Ks create a captive audience, so this terrible funds
exist, just to abuse companies that aren't paying attention, or are getting
something in return of letting employee money get siphoned off.

So sometimes, you are paying a big premium no matter what you do.

~~~
maxxxxx
I still haven't found anyone who could explain to me why there are 401k plans.
Wouldn't it be much easier if people could contribute the same amount to an
IRA where they can invest as they see fit? Why should the employer be able to
pick available investment options for employees?

To me this looks like a subsidy to the financial industry.

~~~
JoeAltmaier
Its that, of course. And its stability in retirement savings - some folks
would put it all in gold mines and internet stocks. And its political - has to
be a managed plan or you can't monitor how much everybody is putting into it,
balance the tax dodging so not only the top employees benefit.

Like anything else, its lots of things put together and evolved.

------
atemerev
As a member of financial industry, I wouldn't say that.

"Active" brokerages are biting the dust? Well, good riddance! Moving people
out of the loop is generally a good idea.

Now, passively managed funds are a good thing, during the growth market.
However, once around every ten years, a recession comes. Then, suddenly,
index-tracking funds become passé, and everyone wants a strategy to survive
the market downfall.

And we have a lot of things to bring in from the current tech state of the
art. Blockchain is ingenious, and the art of defining modern financial
instruments using blockchain features is in its infancy. So, there is a lot of
work to do, and lot of potential to grow.

------
wrong_variable
I wonder what will happen to London. Maybe the housing bubble will finally
burst ?

~~~
TheOtherHobbes
Already happening at the top end. The smart money is talking about moving
elsewhere, especially after the recent tax changes.

The top end - flats worth a million and up - has a long way to fall, because
there's a glut of new build coming onto the market.

The mid and lower ends have a lot more latent demand, but the end of cheap
buy-to-let will force at least some landlords to sell up.

Prices would usually level off, but if sterling keeps drifting lower foreign
money will dump a lot of its speculative holdings. That could crash prices by
big numbers, and also drop rents because many speculative buys are currently
left empty.

~~~
maxxxxx
If the top end collapses the result those buyers may move into lower end
properties and move the prices up even more.

------
arca_vorago
Whats really happening is the the really big players are now extracting wealth
from the middle ones. For the American people, this means the middle class
gets destroyed, but the key here is that lots of people that are technically
"middle class", are really in the top lowerhalf of the 1%, but many of them
don't realize the wave to come.

So once even the 200k/year lawyer down the street is suddenly homeless because
he actually had negative net worth, then it will be too late, but the real
point is that there is no more money to be extracted from the lower classes
except by death by a thousand cuts (taxes), so all the middle men hedge
funders etc are going to be mergered and acquisitioned away as the banks learn
how to manipulate the blockchain market and take it over just like they have
everthing else.

Digitalization of the financial industry is just the buzzword scapegoat they
are going to use to get it done. The same way in which, you see the former
director of NSA leaving and joining a bank, and then yelling doom and gloom
about hackers zeroing out accounts. All that tells me is that is what they
have already planned.

I can see the headline now: "Hacker breach $BANKS, transfer $BILLIONS. Another
bailout unavoidable to prevent collapse."

I've said it before, and I'll say it again, the elite oligarchical
international bankers are closer to terrorists than businessmen.

------
jeffdavis
Is there really such thing as a passive fund?

I have a strong feeling that the contents of the index (or at least weights)
can still be manipulated. And also that the fees are just moving down the food
chain somehow.

If you think I'm wrong, just consider that a public company can own stock in
another public company.

This will all become more obvious when "passive funds" take over more of the
market.

~~~
kasey_junk
I'm not sure I understand what you mean. "Passive" is descriptive of the
strategy & nothing more.

Those funds are trying to mimic the returns of a particular market segment. If
a passive fund argued that a particular market segment had implicit fees &
therefore they charged similar, it would still be passive.

~~~
jeffdavis
The article is talking more about the declining average load due to passive
funds. If the average load goes down, I'm saying that those fees are probably
just moving somewhere else rather than upsetting the industry.

~~~
nostrademons
It moves into the price discovery mechanism of the market. More people in
passive funds => fewer people doing active research on companies => greater
likelihood that the market price of a security doesn't reflect the underlying
fundamentals of the business => arbitrage opportunities for active traders, as
chollida1 pointed out.

People will still get phenomenally rich in the stock market, wealth inequality
will still increase. The difference is that people have to work for it now,
building up their own information advantage, rather than being able to siphon
off large fees simply because they went to a good school and talked a fellow
alum into hiring them. This is a plus in my book.

------
erikb
Sorry but what's the difference between ETFs and index funds? It was presented
to me as the same thing just one word being more common in Europe and the
other more common in the US.

~~~
morgante
ETFs are exchange traded funds are just that: investment funds which trade on
an exchange, where you can invest and divest by trading a symbol.

Index funds are investment funds which seek to match the performance of a
target index.

The concepts are orthogonal. You can have index funds which aren't ETFs and
you can have ETFs which aren't index funds.

~~~
erikb
Quite interesting, thanks.

------
known
"Give me control of a nation's money supply, and I care not who makes its
laws." \--Rothschild since 1744

------
api
They deserve it quite a bit more than the music industry ever did.

------
jldugger
Hurray?

