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Half of US stock fund assets are now invested in index funds


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https://qz.com/1623418/index-funds-now-account-for-half-the-us-stock-market/

 

Investors have put $4.305 trillion into passive US stock market funds as of April 30, only $6 billion shy of the $4.311 trillion overseen by active US equity funds, according to a Morningstar report. This month’s data will very likely show that the passive funds have surpassed those that are actively managed.

 

 

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I think one day this is going to be a very big problem that no one is paying attention to.  Yes, the average investor who can stay the course and average in over time will do well by index investing.  But I think when markets tank, investors tend to show the underlying psychology of leeming behavior. 

 

Over time, the stocks in the indices will be overvalued by a considerable amount...we are seeing it already where there are huge undervaluations in stocks that aren't part of the indices.  This exclusion, combined with the psychology of markets, will create a problem as institutional and retail investors flee the same stocks in search of liquidity.  You will only need one singular moment of panic for this to happen.  Cheers!

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Parsad, Are you saying this is a problem for the companies excluded from indices?  Seems like it might create volatility for both included and excluded issues for different reasons. Sounds like possible opportunities to me. Are you worried?

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Parsad, Are you saying this is a problem for the companies excluded from indices?  Seems like it might create volatility for both included and excluded issues for different reasons. Sounds like possible opportunities to me. Are you worried?

 

Not a problem for those companies not in the index, other than undervaluation for long periods...I'm buying those like hamburgers at half price.  It will be a problem for the broad market included in the indices at some point, and could create a panic.  Cheers!

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Guest longinvestor

Panic driven & untimely liquidation is a broader problem than one to be faced by index fund holders/holdings alone. Munger: "If you cannot bear a 50% decline in your holding, you deserve the mediocrity that you will otherwise get"; This applies to individual stocks, active funds and passive funds.

 

That said, the drumbeat from the fee taking (& underperforming) active fund industry will keep increasing all the way to when there is panic in the markets. The crocodile tears are flowing because of this, https://www.investmentexecutive.com/news/industry-news/mutual-fund-fees-to-fall-by-almost-20-by-2025-report/; Until the market drives the active fund fee regimes to the same zip code as passive funds, the single best thing ordinary folks should do is to shut off the financial media from their lives. By and large, the media does not work for them.

 

The flight to passive funds is by and large great for society. Too bad, Jack Bogle won't be there to see the fruits of his labor. The world needs a new mouthpiece for low fees when panic reigns again. Who will it be, after Bogle (& Buffett to a certain extent)? One can argue that the aging population with meager retirement savings needs low fees more than ever before. Anecdotally, in my circles, the well educated younger professional folks entering the workforce seem to be getting it. I'm talking about well heeled types, doctors et al. They are choosing 100% index funds in their 401K's. All they need to do is weather the next storm or two.

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Parsad, Are you saying this is a problem for the companies excluded from indices?  Seems like it might create volatility for both included and excluded issues for different reasons. Sounds like possible opportunities to me. Are you worried?

 

Not a problem for those companies not in the index, other than undervaluation for long periods...I'm buying those like hamburgers at half price.  It will be a problem for the broad market included in the indices at some point, and could create a panic.  Cheers!

 

I must be missing something, but I don’t see a lot of stock being 50% off, just because they are not in an index. Besides, isn’t almost any stock in some kind of passive index, like the various Russel indexes? The only inefficiency I can see is that with the float being weighed rather than market cap, owner operators are systematically underrepresented.

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Parsad, Are you saying this is a problem for the companies excluded from indices?  Seems like it might create volatility for both included and excluded issues for different reasons. Sounds like possible opportunities to me. Are you worried?

 

Not a problem for those companies not in the index, other than undervaluation for long periods...I'm buying those like hamburgers at half price.  It will be a problem for the broad market included in the indices at some point, and could create a panic.  Cheers!

 

I must be missing something, but I don’t see a lot of stock being 50% off, just because they are not in an index. Besides, isn’t almost any stock in some kind of passive index, like the various Russel indexes? The only inefficiency I can see is that with the float being weighed rather than market cap, owner operators are systematically underrepresented.

 

In todays world we have derivatives, and 'aligned' incentives

Much of the loss on the underlying shares in the index would be offset by index gains on leveraged index puts. There might be a modest index net loss, but there isn't going to be anything major. 'Cause if a material portion of your firms revenue is from index investors ... you will see to it that they do not experience any major loss.

 

SD

 

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Guest cherzeca

dont see the crowded trade in indexes to be a problem.  certainly program/computer driven trading can cause acceleration of effects and even trigger psychological tipping points, but I dont see what indexing contributes to this. 

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dont see the crowded trade in indexes to be a problem.  certainly program/computer driven trading can cause acceleration of effects and even trigger psychological tipping points, but I dont see what indexing contributes to this.

 

If anything is an issue it will be AI and algo trading. We've already seen how many flash crashes the past few years.

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Parsad, Are you saying this is a problem for the companies excluded from indices?  Seems like it might create volatility for both included and excluded issues for different reasons. Sounds like possible opportunities to me. Are you worried?

 

Not a problem for those companies not in the index, other than undervaluation for long periods...I'm buying those like hamburgers at half price.  It will be a problem for the broad market included in the indices at some point, and could create a panic.  Cheers!

 

In my opinion indexing will take much more market share that what it currently does.

 

As for stocks out of the index being significantly cheaper, I don't see a ton of evidence on that:

 

http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/evidence-of-stocks-within-index-with-higher-valuations-of-stocks-not-in-index/msg284928/#msg284928

 

I must be missing something, but I don’t see a lot of stock being 50% off, just because they are not in an index. Besides, isn’t almost any stock in some kind of passive index, like the various Russel indexes? The only inefficiency I can see is that with the float being weighed rather than market cap, owner operators are systematically underrepresented.

 

In todays world we have derivatives, and 'aligned' incentives

Much of the loss on the underlying shares in the index would be offset by index gains on leveraged index puts. There might be a modest index net loss, but there isn't going to be anything major. 'Cause if a material portion of your firms revenue is from index investors ... you will see to it that they do not experience any major loss.

 

SD

 

I remember how in 1999 people used to say that markets wouldn't drop that dramatically or derivatives were not the ticking timebomb that they were...but Buffett, Prem and others did.

 

I remember having a conversation back in 2001 with Sardar and Phil Cooley in Omaha about how I thought money market funds could drop in value and break the $1.00 mark.  It wasn't an original idea by me, but one that made sense to me after listening to Larry Sarbit talk about it could happen.  Sardar went on some long tangent about how the amount of money market redemptions on a daily basis were far below what the daily trading volume of treasury bills were, so it would be unlikely that it could happen.

 

I remember having conversations with people about how the U.S. housing market was not going to go bust in 2007, and mortgaged backed securities were not the issue that a handful of people thought they were.

 

I remember people talking about Vancouver's real estate market like it would go up forever and they could not remember what happened back in 1981 when prices fell 30-40% as interest rates rose.

 

The one thing I know for sure...when you have large amounts of capital drifting into a specific strategy, and that capital starts to make up a fairly significant percentage of available capital, you start to create bubbles where panic will surely arrive at some point in time.  Seth Klarman sees it...I see it happening...a handful of others see it happening.  But it could go on for a long time before a panic happens.

 

All I know is that value investing works and capital should always go to where the greatest values are relative to intrinsic value.  I cannot believe that the optimum utilization of capital is in indices when half the world is going there.  Cheers!

 

I

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Parsad, Are you saying this is a problem for the companies excluded from indices?  Seems like it might create volatility for both included and excluded issues for different reasons. Sounds like possible opportunities to me. Are you worried?

 

Not a problem for those companies not in the index, other than undervaluation for long periods...I'm buying those like hamburgers at half price.  It will be a problem for the broad market included in the indices at some point, and could create a panic.  Cheers!

 

In my opinion indexing will take much more market share that what it currently does.

 

As for stocks out of the index being significantly cheaper, I don't see a ton of evidence on that:

 

http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/evidence-of-stocks-within-index-with-higher-valuations-of-stocks-not-in-index/msg284928/#msg284928

 

I must be missing something, but I don’t see a lot of stock being 50% off, just because they are not in an index. Besides, isn’t almost any stock in some kind of passive index, like the various Russel indexes? The only inefficiency I can see is that with the float being weighed rather than market cap, owner operators are systematically underrepresented.

 

In todays world we have derivatives, and 'aligned' incentives

Much of the loss on the underlying shares in the index would be offset by index gains on leveraged index puts. There might be a modest index net loss, but there isn't going to be anything major. 'Cause if a material portion of your firms revenue is from index investors ... you will see to it that they do not experience any major loss.

 

SD

 

I remember how in 1999 people used to say that markets wouldn't drop that dramatically or derivatives were not the ticking timebomb that they were...but Buffett, Prem and others did.

 

I remember having a conversation back in 2001 with Sardar and Phil Cooley in Omaha about how I thought money market funds could drop in value and break the $1.00 mark.  It wasn't an original idea by me, but one that made sense to me after listening to Larry Sarbit talk about it could happen.  Sardar went on some long tangent about how the amount of money market redemptions on a daily basis were far below what the daily trading volume of treasury bills were, so it would be unlikely that it could happen.

 

I remember having conversations with people about how the U.S. housing market was not going to go bust in 2007, and mortgaged backed securities were not the issue that a handful of people thought they were.

 

I remember people talking about Vancouver's real estate market like it would go up forever and they could not remember what happened back in 1981 when prices fell 30-40% as interest rates rose.

 

The one thing I know for sure...when you have large amounts of capital drifting into a specific strategy, and that capital starts to make up a fairly significant percentage of available capital, you start to create bubbles where panic will surely arrive at some point in time.  Seth Klarman sees it...I see it happening...a handful of others see it happening.  But it could go on for a long time before a panic happens.

 

All I know is that value investing works and capital should always go to where the greatest values are relative to intrinsic value.  I cannot believe that the optimum utilization of capital is in indices when half the world is going there.  Cheers!

 

I

 

Sanj, a money market first broke the buck in 1994. While you were more right than Biglari, it had already happened not too long before.

 

Klarman talked quite a bit about how index funds were a fad back in...1991! Will markets (and indices) have a large drawdown sometime in the future? Yes.

 

Will active managers, as a group, do better during that downturn or subsequent upturn? Highly unlikely.

 

Will a few do a lot better during the downturn? Highly likely.

 

Will those few who did well during the downturn do better than an unmanaged index over, say, 20 years? Pretty unlikely.

 

Will there be a few (some lucky, some truly skilled) that beat an unmanaged index over that same time? Pretty likely.

 

If I had to guess, active managers will continue to struggle. That is what one would expect as markets get more mature and more efficient. The average investment manager should be paid less than a teacher since the teacher actually adds value.

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Guest cherzeca

"I cannot believe that the optimum utilization of capital is in indices when half the world is going there."

 

well with respect to index funds (as opposed to, say, tulips), I can.  transaction costs (including the cost associated with my miscalculating a particular stock's "intrinsic value") are real and largely avoided by indexing.  this is an optimal allocation of a core portion of my capital

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Sanj, a money market first broke the buck in 1994. While you were more right than Biglari, it had already happened not too long before.

 

Let me clarify...the 1st retail money market fund to break the buck.  The 1994 break was institutional.  And when I was talking to Sardar, I wasn't talking about one money market fund...but half the market.  It just didn't happen because the Fed stepped in, in a big way, otherwise it would have been hell.

 

Klarman talked quite a bit about how index funds were a fad back in...1991! Will markets (and indices) have a large drawdown sometime in the future? Yes.

 

I'm not saying they are a fad.  I'm saying it can create a systemic issue, and when you have that type of problem, it creates a panic.  Systemic issues by their very nature take a long-time to fester and appear.  Look, we still aren't sure why the Nasdaq drops a 1000 points in a day...accidental trade, derivatives, algorithmic trading...we still don't know.

 

Will active managers, as a group, do better during that downturn or subsequent upturn? Highly unlikely.

 

Agree.

 

Will a few do a lot better during the downturn? Highly likely.

 

Agree.

 

Will those few who did well during the downturn do better than an unmanaged index over, say, 20 years? Pretty unlikely.

 

Will there be a few (some lucky, some truly skilled) that beat an unmanaged index over that same time? Pretty likely.

 

This is where I disagree.  Good, active managers don't suddenly become idiots.  For example, Francis is not an idiot...Buffett over the last five years is not an idiot.  The number of diminishing brain cells in their head didn't suddenly start compounding at an increasing rate. 

 

If I had to guess, active managers will continue to struggle. That is what one would expect as markets get more mature and more efficient. The average investment manager should be paid less than a teacher since the teacher actually adds value.

 

Agree on active managers struggling.  Are markets getting more mature and efficient, or are we creating systemic anomalies over long periods?

 

I hate that Buffett and Munger quote on teachers being paid more than money managers.  It's amazing that they keep throwing it out there, since it is so hypocritical.  Their legacy is built on money management...that is what they are known for.  Not teaching, not engineering, not innovation...you can't be the Pope and then tell all the Catholics of the world that practicing your religion was ok for you, but not any of them. 

 

I'm not saying John Bogle wasn't Jesus and brought investors into the light.  I'm just saying that too many practicing that religion could create problems in the system...not permanent, but a problem.  Cheers! 

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Capital used to concentrate in the nifty 50; if you were a 'name' you got a higher multiple than the other guy - simply for being in the index. Then, as now, shorting those likely to drop out and buying those likely to replace; was a profitable trade.

 

But even during crashes, the multiples in the nifty 50 remained higher than for the other guy.

Everyones share price declined, but the deeper the markets liquidity pool, the better the share price held up.

Todays index fund is essentially yesterdays nifty 50.

 

Dogma preaches that a MMFund can never ' break a buck'; and that an index run can never happen.

Experience shows that periodically 'dogma' is wrong, and that markets react violently when it occurrs.

Derivatives have given us the tools to exploit it.

 

So what?

At some point there will be a breakdown, and for most it will be debilitating.

But the bigger players will not really be affected; because the scenario is part of the annual stress test.

 

Just a different POV.

 

SD

 

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Sanj,

 

I agree that good, active managers don't suddenly become idiots. With that said, a lot of it is simply due to luck. Also, the value of skills can diminish over time. Back in the 80s it was more difficult to find low priced stocks but now many etfs are available to do that for very little cost.

 

Let's look Chou (who I like as a person but not convinced he is a brilliant investor).

 

From inception to 1/1/08 (just picking this date since it was before the crash and year end) $10,000 invested in Chou Associates would turn out to be about $124,000 vs about $104,000 in S&P 500. Now this is pretty impressive considering the over 2% expense ratio of the fund and better drawdowns. Surprisingly the fund still lost about 30% in 2008 even though he knew about the subprime trade.

 

Now though the situation is not so good- about $185,000 for Chou vs $229,000 for S&P 500 since inception to date. So over 33 years he's underperformed a low cost index...before taxes. Let's skip Chou Opportunity for now since the record on that is horrendous.

 

Yeah, we can say that the fund isn't a domestic fund so comparison isn't valid but it certainly seems like most of his holdings are US based.

 

Will he do better in the next downturn? Maybe. But the drawdown in Chou Opportunity was actually quite a bit worse during the drop late last year than the market. Yeah, I know it was only a few months but one would think it would've held up better. Now, Chou Associates held up about as well as the market but a lot of that is due to the Berkshire holding.

 

Heck, even Buffett said that Berkshire should be roughly in line with the S&P 500 after saying it should beat it buy a small amount in the past.

 

I will agree that we could very well be in sometime of anomaly right now.

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Guest longinvestor

Sanj, .....

 

I hate that Buffett and Munger quote on teachers being paid more than money managers.  It's amazing that they keep throwing it out there, since it is so hypocritical.  Their legacy is built on money management...that is what they are known for.  Not teaching, not engineering, not innovation...you can't be the Pope and then tell all the Catholics of the world that practicing your religion was ok for you, but not any of them. 

 

I'm not saying John Bogle wasn't Jesus and brought investors into the light.  I'm just saying that too many practicing that religion could create problems in the system...not permanent, but a problem.  Cheers!

 

There’ a huge difference between Buffett and the 1000’s of money managers of today who don’t deserve a penny of the fees that they have stolen from their investees. Buffett returned well over any index during his time as a manager. There was also the performance hurdle. Plus he shut it all down when he realized that high expectations of his past would likely not repeat. There’s been over 50 years for a deserving money manager to prove that they are worth something more than what a teacher provides by way of value. The only guarantee has been the fee.

 

I don’t think Buffett should stop talking about this. As I posted before, I’m hoping that someone younger, with credibility will step forward to keep this message alive when Buffett is no longer around. The money management business will do all it can to keep the bonhomie going. It’s too good for them to not.

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