Does Index Investing Reduce Market Efficiency

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Fran K
Posts: 95
Joined: Sat Dec 26, 2020 7:50 pm

Does Index Investing Reduce Market Efficiency

Post by Fran K »

Hey all, it's been a while and I read this interesting article in the journal today that provides some interesting insights into how index investing affects stock prices and price accuracy. Any thoughts?

https://www.wsj.com/articles/clean-ener ... 01?mod=mhp

Edit: I am pretty sure you can get past the paywall by just creating an account without paying. I have pasted an excerpt from the article below that gets at the gist of it.
"Luckily, S&P has provided a perfect natural experiment as it attempts to fix the problems with its overly-narrow index.

The 30 clean-energy stocks are selected based on a score for how clean they are. As of October, more than twice as many were eligible, of which 49 scored the maximum possible, according to data published by S&P as part of a series of attempts to mend the index.


Only 30 can get in, so there were 19 top-scoring stocks that didn’t get picked. And they actually rose more over the period than those in the index. It is hard to square this with the idea that money flowing into the index led to the outsize gains for clean-power stocks.

Top-scoring stocks performed better, whether or not they were in the index, than stocks ranked as eligible, but less clean—companies such as NextEra Energy or Hawaiian Electric. Prices appear to have risen due to the mad rush into all clean-energy stocks, which caused both the cleanest stocks to perform the best and the clean-energy ETFs to soar.

There are a couple of important caveats. It is possible the stocks that weren’t in the ETF rose because of the prospect of being included at some point in future—exactly as happened with Tesla last autumn when the car company finally made a profit and became eligible for the S&P 500. Given the cap of 30 stocks, though, it is hard to see why this should be the case.

It is also possible that the new money going into the ETFs was the primary driver of prices, but that other similar stocks were dragged up as a result. Shareholders could, for example, sell Plug Power (in the index) to the ETF and instead buy FuelCell Energy (not in the index) to maintain their exposure to hydrogen stocks."
Last edited by Fran K on Sat Apr 17, 2021 1:13 pm, edited 1 time in total.
You make more money selling advice than following it. -Steve Forbes
sycamore
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Joined: Tue May 08, 2018 12:06 pm

Re: Does Index Investing Reduce Market Efficiency

Post by sycamore »

Fran K wrote: Sat Apr 17, 2021 12:01 pm Hey all, it's been a while and I read this interesting article in the journal today that provides some interesting insights into how index investing affects stock prices and price accuracy. Any thoughts?

https://www.wsj.com/articles/clean-ener ... 01?mod=mhp
The article is behind a paywall; only the first few paragraphs are readable by those who aren't WSJ subscribers.

Would you mind posting your synopsis of the article, or maybe a few relevant "fair use" snippets you find interesting, so we can discuss it further?
UpperNwGuy
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Joined: Sun Oct 08, 2017 7:16 pm

Re: Does Index Investing Reduce Market Efficiency

Post by UpperNwGuy »

I can't read the article either. What does it say?

Didn't we have another post with approximately the same title earlier today?

Edit: Here it is: viewtopic.php?f=10&t=346388&sid=d3e22b7 ... 76c4974f72
BogleFan510
Posts: 464
Joined: Tue Aug 04, 2020 2:13 pm

Re: Does Index Investing Reduce Market Efficiency

Post by BogleFan510 »

IMHO index investing has little impact on short term price discovery. Markets can still set prices just fine.

To the extent the efficiency and excellent risk/reward history of passive indexes might encourage the average investor to choose stocks (over bonds, CDs, real estate, etc) as a vehicle for savings, there might be an overall impact on market values (lowers risk premium a bit, increases in PEs paid). I would guess the performance of passive indexes has shifted money into them and raised stock prices some. Likely this is justified by their ability to remove many investing risks from less efficient historic portfolios.

So I would guess that the bigger price impacts are from 1) overall popularity of stock investing among all capital holders (lots of funds flowing into stocks), 2) perceived risk reductions to a diversified stock portfolio via very efficient ETFs and 3) perceived risk reduction to stocks from federal government willingness to intervene in markets and offer a financial safety net to companies and by proxy stockholders. So, overall the long bull market and perceived risk rewards have made US stocks very popular. Whether future earnings will continue to support this is an unknown. I hope so.
Topic Author
Fran K
Posts: 95
Joined: Sat Dec 26, 2020 7:50 pm

Re: Does Index Investing Reduce Market Efficiency

Post by Fran K »

sycamore wrote: Sat Apr 17, 2021 12:26 pm
Fran K wrote: Sat Apr 17, 2021 12:01 pm Hey all, it's been a while and I read this interesting article in the journal today that provides some interesting insights into how index investing affects stock prices and price accuracy. Any thoughts?

https://www.wsj.com/articles/clean-ener ... 01?mod=mhp
The article is behind a paywall; only the first few paragraphs are readable by those who aren't WSJ subscribers.

Would you mind posting your synopsis of the article, or maybe a few relevant "fair use" snippets you find interesting, so we can discuss it further?
See edit above.
You make more money selling advice than following it. -Steve Forbes
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bertilak
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Re: Does Index Investing Reduce Market Efficiency

Post by bertilak »

"Does Index Investing Reduce Market Efficiency"

When I see articles like this (and there are TONS of them) I always think "Gee, I wish my investments had that power. If they did I'd go to the trouble of seeing how I could profit from it!
May neither drought nor rain nor blizzard disturb the joy juice in your gizzard. -- Squire Omar Barker (aka S.O.B.), the Cowboy Poet
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