Blackrock Ditching Active Human Management

[clutch]

"I'd argue that in general, the greater the variance in performances indicates the greater the irrationality in the market"

 

Upon first glance maybe, but think of all the crashes in history. In the irrational period prior to the crashes, was there a wide or narrow performance variance? Seems like it narrows as we approach a crash, at least to me.

 

BTW, the variance I stated here is the variance of the returns of all investors. Higher variance would indicate more people are using leverages, derivatives, concentrating bets, etc. In contrast, if everyone bought the same index ETF, the variance would be zero.

[txitxo]

 

 

The Nifty Fifty of the early 70's is a near perfect example of exactly what index funds are doing today.  Valuations on the highest weighted stocks are getting driven higher and higher, as are valuations of lesser companies within the index.  It has become a self reinforcing cycle.  So, you have a situation where the biggest few hundred companies are getting lofiter and loftier in valuation, with no underlying earnings growth. 

 

The money keeps pouring into the index funds, driving the markets to valuations nearly double what they were in 2011, and there has been no earnings growth over that time.  Index funds are sowing the seeds of the next bear market, and serving to increase the potential volatility.  WHEN a panic hits the formerly "passive" investors will become active and the downside will get exaggerated in speed and depth. 

 

 

Exactly, uccmal. I fully agree with you. What happens if the CAPE goes to 100? Passive investing tells you to keep putting *all* your savings into those crazily  expensive stocks. People think that buying the SPY is as safe and worry-free as buying houses a decade ago or tulips in Amsterdam. We all know how that ends.

[clutch]

I thought a bit more about this topic...

 

So here is an interesting observation. Passive investing only works IF there is enough people who are actively investing!

 

Let's assume that active investors (most of them) are trying to allocate their capital into the most productive companies. As a group, they create the market, and this market seems to be the most efficient way of allocating capital, based on the free market principles (I'm not saying that the market is efficent in the absolute sense as in the efficient market theory. Obviously there are a bunch of irrational behaviors. I'm just saying that as a whole it's more efficient than any other system...e.g., government dictated allocation).

 

So we have this relatively efficient market created by active investors. What passive investors try to do is take advantage of this, without "actively participating" in the market. I put in quotes "actively participating" because if the money put in by passive investors is small enough, it won't affect the market much.

 

What would happen if everyone becomes a passive investor? And let's say they all buy the cap weighted index fund - such a case would result in a totally irrational market where more capital goes to companies with bigger market caps, which in turn make their market caps bigger, which in turn attracts more capital and so on...a vicious feedback loop that becomes completely detached from the business fundamentals.

 

So I see the concerns expressed by others in this thread. Basically, when the money contributed by the passive investors becomes significant, it starts making the market more inefficient. I don't know what's the portion of passively invested money in the total market right now...but it certainly looks to be growing more and more.

 

Then, is passive investing just another market destroying mechanism? Currently, it could be, but that's because the majority of passive investing vehicles simply attempts to track the market. It does not allocate capital based on the business fundamentals. However, we are already starting to see a variety of ETFs being created every year, some of them based on business fundamentals (e.g., there are value-oriented ETFs) or even tracking some "guru" investors.

 

My feeling is that we are going to see more passive investing vehicles that not only try to track the market but also participate in making the market in such a way that it maximizes the total market return. If that is possible, it will now create a virtuous feedback loop that allocates more and more capital to the most productive businesses! And this obviously would benefit the society as a whole - capital is allocated in the most efficient way possible to the companies and the investors equally take advantage of this productivity.

 

Now this might be a pipe dream and seems incomprehensible at this moment... but as we become better and better at leveraging the computational power / "intelligence" of machines to solve more complex problems... Maybe this is another problem we can crack in the future!  ;)

 

[SharperDingaan]

Blackrock is simply being extremely smart here ...

 

Assume the 80:20 rule applies to them as well, as it does to everywhere else.

Those $ going into sector specific ETFs weren't making them much, after paying the bodies to hold their hands (ie: part of the 80%). So ... get rid of the bodies, cut the payroll, save on rental space, & lower the break-even.

 

Most ETF's cannot be shorted.

Except that if you created it, all you need do is mirror it with puts in a house account - creating a 100% short. But you would actually go 100%++, as you & every other house on the street, is concentrating the ETF on the same few names (nifty 50 effect). Everybody selling the same names, at the same time, making the house very very rich.

 

Very limited risk.

The names are core companies; if they get into trouble they will be bailed out to protect the jobs, and the more so if all the names in the industry sector are in trouble at the same time - with a little help from a collapsing ETF ;)

 

A wise man would quietly put a short straddle on the more vulnerable sectors, & let Blackrock continue paying the freight.

They take the blame, you take the profit, & little they can do about it.

 

Karma's a bitch.

 

SD

 

 

 

 

 

 

 

 

 

   

[John Hjorth]

clutch,

 

I'm by no mean sure, that I agree with you.

 

How do you define a market participant? To me, it seems like you are defining market participant as a long shareholder [directly, or indirectly, via a ETF or mutual fund], a short, or a buyer or seller of options.

 

To me, a market participant is an entity [physical person, company, fund - whatever] with actual orders in the market.

 

At least a part of the passive investors do not act in accordance with patterns described earlier in this topic by Uccmal et al. [<- no pun intended here!].

 

The proof of this statement is actually the behavior of quite some members of this board [Please see attached].

 

- - - o 0 o - - -

 

I [i write "I", on behalf of my family and my self] consider my self a passive investor, and when I'm not in the market with orders, I'm not a participant in the market - just an owner of some fractions of specific companies, bought at an earlier point in time.

 

My point here is also : How do you define "passive"? Let me just say, on this board it is relative.

 

I would say, that BRK is not a market participant with regard to KO, since the last of the original 200 M shares of KO [now 400 M shares] was bought a long time ago [at least, as far as we know by now, with regard to market participation].

CoBF_screen_shot_board_index_20150824.docx

[clutch]

clutch,

 

I'm by no mean sure, that I agree with you.

 

How do you define a market participant? To me, it seems like you are defining market participant as a long shareholder [directly, or indirectly, via a ETF or mutual fund], a short, or a buyer or seller of options.

 

To me, a market participant is an entity [physical person, company, fund - whatever] with actual orders in the market.

 

At least a part of the passive investors do not act in accordance with patterns described earlier in this topic by Uccmal et al. [<- no pun intended here!].

 

The proof of this statement is actually the behavior of quite some members of this board [Please see attached].

 

- - - o 0 o - - -

 

I [i write "I", on behalf of my family and my self] consider my self a passive investor, and when I'm not in the market with orders, I'm not a participant in the market - just an owner of some fractions of specific companies, bought at an earlier point in time.

 

My point here is also : How do you define "passive"? Let me just say, on this board it is relative.

 

I would say, that BRK is not a market participant with regard to KO, since the last of the original 200 M shares of KO [now 400 M shares] was bought a long time ago [at least, as far as we know by now, with regard to market participation].

 

By "passive" I meant an investor who invests money on entire or a big chunk of market based on some predefined capital allocation scheme.

 

When I say a "market participant" it is every individual that holds some equity in the market. My point is that the passive investors as I defined above, take advantage of the market created by all the market participants as a whole.