Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Topic Author
dignan
Posts: 84
Joined: Mon Nov 23, 2015 12:01 pm
Location: chicago

Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by dignan »

Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)
https://www.bloomberg.com/news/audio/20 ... et-podcast
Over the last decade or so, we’ve seen an incredible rise in so-called passive investing. While definitions differ over what this means, we’ve seen more and more money poured into index funds (which own every stock in a given basket). Meanwhile, money has been yanked away from money managers who attempt to select individual stocks. One school of thought argues that this is a positive, in part due to lower fees. But is there a dark side? On this week’s episode, we speak to Mike Green of hedge fund Logica Capital, who argues that the trend is causing major market distortions that will eventually unwind with ugly consequences.
I found this podcast very interesting and thought I'd share it for discussion. If fund managers think that passive funds are creating an issue in the market, then why don't they make their active funds more transparent, inexpensive and desirable to invest in?
Last edited by dignan on Wed Feb 19, 2020 12:05 pm, edited 1 time in total.
User avatar
jhfenton
Posts: 4754
Joined: Sat Feb 07, 2015 10:17 am
Location: Ohio

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by jhfenton »

Says a hedge fund manager whose livelihood depends on people avoiding index funds.

Wake me up when 80-90% of the equity market is indexed, and we can have a debate about at what level price discovery would break down.
garlandwhizzer
Posts: 3565
Joined: Fri Aug 06, 2010 3:42 pm

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by garlandwhizzer »

Regarding problems with passive index investing, quote from article:

But is there a dark side? On this week’s episode, we speak to Mike Green of hedge fund Logica Capital, who argues that the trend is causing major market distortions that will eventually unwind with ugly consequences.
Major market distortions, bubble creation and the popping of bubbles, has been occurring in markets on a regular basis for centuries prior to the discovery on passive indexing. The bubble on 1929 which popped with the Great Depression occurred decades before Bogle first spoke of indexing as an investment style. The Dutch Tulip Bulb Bubble wasn't driven by index investing nor was the dot.com/tech bubble which was largely driven by active MOM/tech investors. Markets have always and will always periodically develop distortions until the Minsky Moment occurs and it falls apart. The underlying problem creating this is not indexing but rather human nature, the persistent chase after rapidly appreciating winners and neglect of recent losers, which happens with both active and passive approaches. Interesting that Mike Green is a hedge fund guy. If you have absurdly high fees as hedge funds do, and you have consistently underperformed simple indexes for more than a decade, I guess you have to say something.

Garland Whizzer
rbaldini
Posts: 1444
Joined: Mon Mar 23, 2015 3:20 pm

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by rbaldini »

Not sure how indexes that purchase stock *in proportion to their market cap* could "distort" the market...
User avatar
firebirdparts
Posts: 4412
Joined: Thu Jun 13, 2019 4:21 pm
Location: Southern Appalachia

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by firebirdparts »

The problem with this and the other 1000 active managers who complained about it is that the effects of the actual passivity are so few. When you read/listen, you need to filter out everything that would be caused by active investors and see what you're left with.

What you're left with is that some of us don't participate in price discovery as much as we might have. If index funds are outlawed tomorrow, our involvement in price discovery will be mildly affected.
This time is the same
User avatar
nisiprius
Advisory Board
Posts: 52215
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by nisiprius »

1) Index ETFs trade freely on the open market, and buy and sell stocks freely on the open market, so how can they be "distorting" the market? They are simply the product of free-market activity. When a bubble occurs, like the tech bubble of 2000, nobody said that Henry Blodget or Maria Bartiroma was "distorting" the market. I could say that active managers are distorting the market--and that, too, would be nonsense.

2) When money is "poured into" an asset that is only part of the market, because of supply and demand it causes a scarcity and raises the price of the asset relative to other assets. This can happen with an individual stock, with sectors, with asset classes such as "small-cap value."

The only exception to this is broad market index funds. When money is "poured into" in a broad market index fund, the dollar composition of stocks remaining in the market does not change. No scarcities are created, no stock prices are driven up relative to others.

We share the pot of chicken soup with active managers. We are not hogging the dumplings. We put the ladle into a pot of soup that is 20% dumplings, and stir it up well. The ladleful we take out is 20% dumplings, and what is left in the pot is 20% dumplings. We are not making it any harder for active managers to find the dumplings.

I don't know if Mike Green actually understands this perfectly well, or whether he himself is confused about it. I'm not going to spend forty-five minutes listening just to find out, but if someone knows the URL for a transcript I'd appreciate it.

A general enthusiasm for stocks can of course create a rising tide that lifts all boats, and the entire stock market can be in a bubble, but that is a consequence of investors buying stocks, not investors buying index funds.
Last edited by nisiprius on Wed Feb 19, 2020 1:06 pm, edited 4 times in total.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
User avatar
firebirdparts
Posts: 4412
Joined: Thu Jun 13, 2019 4:21 pm
Location: Southern Appalachia

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by firebirdparts »

nisiprius wrote: Wed Feb 19, 2020 12:58 pm A general enthusiasm for stocks can of course create a rising tide that lifts all boats, and the entire stock market can be in a bubble, but that is a consequence of investors buying stocks, not investors buying index funds.
If you put your money into stocks, your offer will have to convince somebody else to sell. That's the key. There has to be somebody willing to be influenced by price. The reverse is also true. A reasonable person would see, based on this, passive investing would increase volatility as you get close to the limit. It has to, a lot. It may have only happened once before on the NYSE in living memory, on October 29 1929. We're seeing the opposite.
There are more derivatives than stocks. The gamblers contribute a very great deal to price discovery.

I listened about halfway through, but I got bored with it. Pretty sophomoric. I don't know if they don't understand it, or if they're pretending not to.
Last edited by firebirdparts on Wed Feb 19, 2020 1:41 pm, edited 1 time in total.
This time is the same
User avatar
bertilak
Posts: 10725
Joined: Tue Aug 02, 2011 5:23 pm
Location: East of the Pecos, West of the Mississippi

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by bertilak »

firebirdparts wrote: Wed Feb 19, 2020 12:33 pm The problem with this and the other 1000 active managers who complained about it is that the effects of the actual passivity are so few. When you read/listen, you need to filter out everything that would be caused by active investors and see what you're left with.

What you're left with is that some of us don't participate in price discovery as much as we might have. If index funds are outlawed tomorrow, our involvement in price discovery will be mildly affected.
But, to the point where it makes a difference, someone will jump in to take advantage of any discrepancies created. If the discrepancies are not enough to jump on they are not enough to worry about.
May neither drought nor rain nor blizzard disturb the joy juice in your gizzard. -- Squire Omar Barker (aka S.O.B.), the Cowboy Poet
Jack FFR1846
Posts: 18501
Joined: Tue Dec 31, 2013 6:05 am
Location: 26 miles, 385 yards west of Copley Square

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by Jack FFR1846 »

I found one claim interesting. That passive investors pump money into the popular indexes, propping up those companies at the top of the indexes, making it harder for active managers to outperform because these indexes keep getting passive money, so keep doing better. My answer to that: "If you active managers see this happening and aren't smart enough to make that an advantage to your fund, then maybe you have a promising career flipping burgers".

I found that Mike was quite good at making excuses and rationalizing why active managers aren't able to beat passive. My only concern in investing is whether I'm getting market return at low cost. If active was destroying passive results, there would be more to analyze and consider.....but it doesn't. If Logica's strategy is to cry about the fact that they add no value, then perhaps they need to try harder.
Bogle: Smart Beta is stupid
User avatar
bertilak
Posts: 10725
Joined: Tue Aug 02, 2011 5:23 pm
Location: East of the Pecos, West of the Mississippi

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by bertilak »

Jack FFR1846 wrote: Wed Feb 19, 2020 1:42 pm If Logica's strategy is to cry about the fact that they add no value, then perhaps they need to try harder.
:D
May neither drought nor rain nor blizzard disturb the joy juice in your gizzard. -- Squire Omar Barker (aka S.O.B.), the Cowboy Poet
EnjoyIt
Posts: 8272
Joined: Sun Dec 29, 2013 7:06 pm

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by EnjoyIt »

If we ever got to a point of too much indexers then the market would become inefficient. Plenty of smart investors would recognize that inefficiency and jump ship from indexing to take advantage of those inefficiencies. Obviously that would make the market efficient again.

TLDR; indexers will never be 100% of the market.
A time to EVALUATE your jitters: | viewtopic.php?p=1139732#p1139732
inbox788
Posts: 8372
Joined: Thu Mar 15, 2012 5:24 pm

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by inbox788 »

dignan wrote: Wed Feb 19, 2020 11:33 amIf fund managers think that passive funds are creating an issue in the market, then why don't they make their active funds more transparent, inexpensive and desirable to invest in?
Wrong questions. Distorting how? Raising prices? Keeping prices low? Less efficient? And when the market unwinds, what are these ugly consequences they're predicting? These active managers should welcome market inefficiencies and if they're good at what they claim, profit handsomely from these consequences. They can't be transparent, as that would give away their advantage, and it costs to generate this alpha. And if they were desirable to invest in, they should be charging more, not less.
JonnyB
Posts: 688
Joined: Sun Jan 19, 2020 4:28 pm

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by JonnyB »

firebirdparts wrote: Wed Feb 19, 2020 12:33 pm What you're left with is that some of us don't participate in price discovery as much as we might have.
I love these goofy terms traders come up with to describe their trading to make it seem more important and mysterious. "I'm not just trading stocks, I'm price discovering."

I was at the grocery yesterday. I saw that a dozen eggs was up a nickel from last week. I decided to buy anyway. Price discovery!
Seasonal
Posts: 3045
Joined: Sun May 21, 2017 1:49 pm

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by Seasonal »

Prior posters have given excellent responses. I'll add the great Upton Sinclair quote: “It is difficult to get a man to understand something, when his salary depends upon his not understanding it!”
User avatar
nisiprius
Advisory Board
Posts: 52215
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by nisiprius »

firebirdparts wrote: Wed Feb 19, 2020 1:37 pm...If you put your money into stocks, your offer will have to convince somebody else to sell. That's the key. There has to be somebody willing to be influenced by price. The reverse is also true. A reasonable person would see, based on this, passive investing would increase volatility as you get close to the limit. It has to, a lot....
You seem to be talking about price insensitivity versus price sensitivity. You haven't explained why passive investing cause stock market volatility, but not active investing.

1) Consider 401(k) savers who put their purchases on autopilot, and happen to choose active funds for their contributions. "I will buy $300 worth of Fidelity Freedom 2040 every month, no matter what." These are active investors who, nevertheless, are price insensitive. Aren't they increasing stock market volatility?

2) Consider Bogleheads forum posters who are reluctant to put more money into Total Stock because they think US stocks are expensive. These are passive investors who, nevertheless, are price-sensitive.
It may have only happened once before on the NYSE in living memory, on October 29 1929.
It requires a leap of the imagination to attribute anything about the behavior of the stock market in 1929 to volatility increases caused by passive investing, given that the first index fund was launched in 1976. I assume you mean that volatility was caused by active investors, because that is all there were back then.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
User avatar
Phineas J. Whoopee
Posts: 9675
Joined: Sun Dec 18, 2011 5:18 pm

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by Phineas J. Whoopee »

What do odd lots have to do with anything? Does somebody honestly think large institutions are buying shares seven at a time?

It's the same old argument from the croupiers dressed up in different words. I don't blame them individually. They may not know where next month's boat payment is coming from.

If investors in index funds would put the same amount into stocks anyway, the effect on the market would be the same. The total market aggregate would have the same trajectory.

The same old same old is the unstated implication that index fund investors wouldn't buy stocks at all if indexing weren't available.

It's bunk.

PJW
h82goslw
Posts: 493
Joined: Fri Jun 17, 2016 5:44 am

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by h82goslw »

jhfenton wrote: Wed Feb 19, 2020 11:45 am Says a hedge fund manager whose livelihood depends on people avoiding index funds.

Wake me up when 80-90% of the equity market is indexed, and we can have a debate about at what level price discovery would break down.
So this makes me wonder....what percentage of the equity market is indexed now? We've all heard that people are flocking to passive investing using index funds...what's the real number?
Topic Author
dignan
Posts: 84
Joined: Mon Nov 23, 2015 12:01 pm
Location: chicago

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by dignan »

h82goslw wrote: Wed Feb 19, 2020 3:28 pm
jhfenton wrote: Wed Feb 19, 2020 11:45 am Says a hedge fund manager whose livelihood depends on people avoiding index funds.

Wake me up when 80-90% of the equity market is indexed, and we can have a debate about at what level price discovery would break down.
So this makes me wonder....what percentage of the equity market is indexed now? We've all heard that people are flocking to passive investing using index funds...what's the real number?
It looks like "market share for passively managed funds has risen to 45 percent" in 2019.
https://www.cnbc.com/2019/03/19/passive ... arket.html
User avatar
Phineas J. Whoopee
Posts: 9675
Joined: Sun Dec 18, 2011 5:18 pm

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by Phineas J. Whoopee »

h82goslw wrote: Wed Feb 19, 2020 3:28 pm
jhfenton wrote: Wed Feb 19, 2020 11:45 am Says a hedge fund manager whose livelihood depends on people avoiding index funds.

Wake me up when 80-90% of the equity market is indexed, and we can have a debate about at what level price discovery would break down.
So this makes me wonder....what percentage of the equity market is indexed now? We've all heard that people are flocking to passive investing using index funds...what's the real number?
No doubt somebody will find an approximate numerical answer, but that's another unstated implication, which I'm not blaming you for. The implication is the only investors in the stock market are individuals using mutual funds. Really we're a minor part. Most of the value, and nearly all the daily volume, comes from institutional investors, who make their own detailed allocation decisions day by day, and sometimes even hour by hour.

Edited to add: Your link is only talking about mutual funds, not all market participants, of whom we're a minority. That's why they're careful to include the word funds in every paragraph. I don't know why they're so careful not to point out the rest of the numbers. A Yiddish proverb, probably shared by many other cultures, is half a truth is a whole lie.

PJW
User avatar
SimpleGift
Posts: 4477
Joined: Tue Feb 08, 2011 2:45 pm

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by SimpleGift »

jhfenton wrote: Wed Feb 19, 2020 11:45 am Wake me up when 80-90% of the equity market is indexed, and we can have a debate about at what level price discovery would break down.
Good to keep in mind that it's the amount of active trading that determines efficient market pricing, not the percentage of assets that are actively or passively managed. The chart below posits 100% turnover annually for actively-managed equity and 10% annually for passive equity.
  • Image
    NOTE: Assumes active turnover is 100% annually and passive is 10%.
    Chart adapted from S&P-Dow Jones.
With these conservative turnover assumptions, if half of the market is indexed (in red above), active managers will still do 91% of the trading. Indeed, even if 90% of the market is indexed, active managers will still be doing 53% of the trading — making it very unlikely that indexing will ever have a significant impact on market efficiency and price discovery.
Puretaxableindexer
Posts: 218
Joined: Sun Feb 16, 2020 7:05 pm

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by Puretaxableindexer »

Don't buy the argument that passive is the problem, it's active mgt that's complaining about it in the press, CNBC, Bloomberg, because they are losing AUM. If you think about it, active funds would still invest in these same exact companies that are pushing upwards because they too are closet indexers charging higher fees. Remember the DotCom era where most of those Dotcom companies weren't making any money but active managers were pilling in despite this because they had no choice and other actives were doing the same thing. If a manager underperforms, AUM goes down, less fees and the active mgr gets fired.

Active is BS. Research and analysis is BS. Actives just pick the same driving stocks and weights them higher than the index.
User avatar
JoMoney
Posts: 16260
Joined: Tue Jul 23, 2013 5:31 am

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by JoMoney »

I'm sure increasing "passive investment" is hard on active managers.
It shrinks the pool of "dumb money". When the people who have no special information acknowledge that by adopting an appropriate strategy, it makes it more likely that when actively trading the person on the other side of the transaction has better information than they do.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham
bberris
Posts: 2420
Joined: Sun Feb 20, 2011 8:44 am

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by bberris »

JoMoney wrote: Thu Feb 20, 2020 8:39 am I'm sure increasing "passive investment" is hard on active managers.
It shrinks the pool of "dumb money". When the people who have no special information acknowledge that by adopting an appropriate strategy, it makes it more likely that when actively trading the person on the other side of the transaction has better information than they do.
But shouldn't this large pool of passive investors be the dumb money and easy pickins for those super smart active managers? If active managers outperform, where are they supposed to get their outperformance from, if not from us dumb rubes who trade without any bias or information?
User avatar
firebirdparts
Posts: 4412
Joined: Thu Jun 13, 2019 4:21 pm
Location: Southern Appalachia

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by firebirdparts »

bberris wrote: Fri Feb 21, 2020 5:05 am But shouldn't this large pool of passive investors be the dumb money and easy pickins for those super smart active managers? If active managers outperform, where are they supposed to get their outperformance from, if not from us dumb rubes who trade without any bias or information?
No. It's not working like that at all.
This time is the same
Seasonal
Posts: 3045
Joined: Sun May 21, 2017 1:49 pm

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by Seasonal »

bberris wrote: Fri Feb 21, 2020 5:05 amBut shouldn't this large pool of passive investors be the dumb money and easy pickins for those super smart active managers? If active managers outperform, where are they supposed to get their outperformance from, if not from us dumb rubes who trade without any bias or information?
No. Outperforming active managers get their outperformance from underperforming active investors. Passive investors don't outperform or underperform the market (before fees); they mirror the market. That's how a market index works.
User avatar
nisiprius
Advisory Board
Posts: 52215
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by nisiprius »

dignan wrote: Wed Feb 19, 2020 3:45 pm
h82goslw wrote: Wed Feb 19, 2020 3:28 pm
jhfenton wrote: Wed Feb 19, 2020 11:45 am Says a hedge fund manager whose livelihood depends on people avoiding index funds.

Wake me up when 80-90% of the equity market is indexed, and we can have a debate about at what level price discovery would break down.
So this makes me wonder....what percentage of the equity market is indexed now? We've all heard that people are flocking to passive investing using index funds...what's the real number?
It looks like "market share for passively managed funds has risen to 45 percent" in 2019.
https://www.cnbc.com/2019/03/19/passive ... arket.html
Yeeeeessssss, that statistic is being quoted a lot lately by people decrying the evils of indexing, but it's asset share of US stock-based funds. They usually leave out the detail that mutual funds and ETFs combined only hold 30% of the stock market, and incidentally that number is not increasing:
in recent years, they have held a fairly stable share of the securities outstanding across a variety of asset classes. At year-end 2018, investment companies held approximately 30 percent of the shares of US-issued equities outstanding.
So the meaningful number isn't "45%." It's 45% of 30% = 14%. Not nearly as alarming.

(When I began paying attention to such details, which was perhaps 2009 or thereabouts, the world's largest mutual fund was the PIMCO Total Return Fund, a bond fund which had something like $400 billion in assets. Total Stock, all share classes, was considerably smaller. The PIMCO fund's assets plummeted when star manager Bill Gross left, losing about 2/3rds of its asset in a year, while continuing to perform just fine--I mention that because people sometimes think a fund must tank when investors "run for the exits." Anyway. Total Stock now has over $900 billion in assets. With reasonable luck it should hit a trillion sometime soon. The US stock market, grand total, is something in the ballpark of $35 trillion, so Total Stock alone now holds 2.6% of all US stocks, and thus all by itself is over 8% of the mutual-fund-and-ETF market. I don't find that alarming, though I'm sure Vanguard's competitors do.)
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
User avatar
JoMoney
Posts: 16260
Joined: Tue Jul 23, 2013 5:31 am

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by JoMoney »

bberris wrote: Fri Feb 21, 2020 5:05 am
JoMoney wrote: Thu Feb 20, 2020 8:39 am I'm sure increasing "passive investment" is hard on active managers.
It shrinks the pool of "dumb money". When the people who have no special information acknowledge that by adopting an appropriate strategy, it makes it more likely that when actively trading the person on the other side of the transaction has better information than they do.
But shouldn't this large pool of passive investors be the dumb money and easy pickins for those super smart active managers? If active managers outperform, where are they supposed to get their outperformance from, if not from us dumb rubes who trade without any bias or information?
There is no outperformance in aggregate, the market doesn't return anything extra from people trading. The broad market-cap weighted index represents the markets return. To the extent that some do outperform, there has to be some portfolios that underperform, but passive investors will get the broad average.
Warren Buffett in 1993 BRK Letter wrote: https://www.berkshirehathaway.com/letters/1993.html
...By periodically investing in an index fund, for example, the know-
nothing investor can actually out-perform most investment
professionals. Paradoxically, when "dumb" money acknowledges its
limitations, it ceases to be dumb.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham
User avatar
bertilak
Posts: 10725
Joined: Tue Aug 02, 2011 5:23 pm
Location: East of the Pecos, West of the Mississippi

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by bertilak »

firebirdparts wrote: Fri Feb 21, 2020 5:48 am
bberris wrote: Fri Feb 21, 2020 5:05 am But shouldn't this large pool of passive investors be the dumb money and easy pickins for those super smart active managers? If active managers outperform, where are they supposed to get their outperformance from, if not from us dumb rubes who trade without any bias or information?
No. It's not working like that at all.
Another way of stating it is that active investors fight it out amongst themselves and passive investors accept the results.
May neither drought nor rain nor blizzard disturb the joy juice in your gizzard. -- Squire Omar Barker (aka S.O.B.), the Cowboy Poet
Call_Me_Op
Posts: 9881
Joined: Mon Sep 07, 2009 2:57 pm
Location: Milky Way

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by Call_Me_Op »

Stay the course.
Best regards, -Op | | "In the middle of difficulty lies opportunity." Einstein
alluringreality
Posts: 1511
Joined: Tue Nov 12, 2019 9:59 am

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by alluringreality »

nisiprius wrote: Fri Feb 21, 2020 6:34 am
dignan wrote: Wed Feb 19, 2020 3:45 pm
h82goslw wrote: Wed Feb 19, 2020 3:28 pm
jhfenton wrote: Wed Feb 19, 2020 11:45 am Says a hedge fund manager whose livelihood depends on people avoiding index funds.

Wake me up when 80-90% of the equity market is indexed, and we can have a debate about at what level price discovery would break down.
So this makes me wonder....what percentage of the equity market is indexed now? We've all heard that people are flocking to passive investing using index funds...what's the real number?
It looks like "market share for passively managed funds has risen to 45 percent" in 2019.
https://www.cnbc.com/2019/03/19/passive ... arket.html
Yeeeeessssss, that statistic is being quoted a lot lately by people decrying the evils of indexing, but it's asset share of US stock-based funds. They usually leave out the detail that mutual funds and ETFs combined only hold 30% of the stock market, and incidentally that number is not increasing:
in recent years, they have held a fairly stable share of the securities outstanding across a variety of asset classes. At year-end 2018, investment companies held approximately 30 percent of the shares of US-issued equities outstanding.
So the meaningful number isn't "45%." It's 45% of 30% = 14%. Not nearly as alarming.
Thank you for posting. Using the estimated value of the US stock market, and the value figure for US stock indexing reported by the WSJ last year, I also calculate that indexing probably accounts for less than 15% of the total US stock market value.
45% US Indexes, 25% Ex-US Indexes, 30% Fixed Income - Buy & Hold
User avatar
Forester
Posts: 2400
Joined: Sat Jan 19, 2019 1:50 pm
Location: UK

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by Forester »

Michael Green goes into significantly more detail here, on why he believes passive is distorting the market.

https://www.youtube.com/watch?v=6SVEaK7eDNk
Amateur Self-Taught Senior Macro Strategist
petulant
Posts: 3601
Joined: Thu Sep 22, 2016 1:09 pm

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by petulant »

Forester wrote: Sat Jun 06, 2020 6:44 am Michael Green goes into significantly more detail here, on why he believes passive is distorting the market.

https://www.youtube.com/watch?v=6SVEaK7eDNk
Can you provide a quote or summary or transcript?
User avatar
Forester
Posts: 2400
Joined: Sat Jan 19, 2019 1:50 pm
Location: UK

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by Forester »

petulant wrote: Sat Jun 06, 2020 7:05 am
Forester wrote: Sat Jun 06, 2020 6:44 am Michael Green goes into significantly more detail here, on why he believes passive is distorting the market.

https://www.youtube.com/watch?v=6SVEaK7eDNk
Can you provide a quote or summary or transcript?
Afraid not, it's beyond me, there are people more informed than myself who could digest his points.
Amateur Self-Taught Senior Macro Strategist
bberris
Posts: 2420
Joined: Sun Feb 20, 2011 8:44 am

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by bberris »

When someone posts a Youtube video titled "Active Investors Distort the Market", I'll put that on my watch list.
afan
Posts: 8193
Joined: Sun Jul 25, 2010 4:01 pm

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by afan »

I don't know why I subjected myself to the whole thing, but I was waiting for him to offer some evidence for his claims. The best part was when he smugly explained that active management is working great. It only appears to be trailing the market when one inappropriately compares active performance to the indexes. If one compared active managers to something else -never says what- then we would see just how easily they earn their keep.
I hope for the sake of Bloomgerg's business that this guy paid them to come on and talk this nonsense.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama
User avatar
SimpleGift
Posts: 4477
Joined: Tue Feb 08, 2011 2:45 pm

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by SimpleGift »

For a simple, easy-to-understand outline of why it's impossible for passive investors in total market stock funds to distort market pricing, see this thread from a couple of years ago:

Chart: Why Broad, Cap-weighted Index Funds Can't Move Markets

Anyone who believes total market funds move markets either doesn't grasp the basics, or refuses to grasp them.
Ferdinand2014
Posts: 2390
Joined: Mon Dec 17, 2018 5:49 pm

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by Ferdinand2014 »

SimpleGift wrote: Wed Feb 19, 2020 4:29 pm
jhfenton wrote: Wed Feb 19, 2020 11:45 am Wake me up when 80-90% of the equity market is indexed, and we can have a debate about at what level price discovery would break down.
Good to keep in mind that it's the amount of active trading that determines efficient market pricing, not the percentage of assets that are actively or passively managed. The chart below posits 100% turnover annually for actively-managed equity and 10% annually for passive equity.
  • Image
    NOTE: Assumes active turnover is 100% annually and passive is 10%.
    Chart adapted from S&P-Dow Jones.
With these conservative turnover assumptions, if half of the market is indexed (in red above), active managers will still do 91% of the trading. Indeed, even if 90% of the market is indexed, active managers will still be doing 53% of the trading — making it very unlikely that indexing will ever have a significant impact on market efficiency and price discovery.
Interesting. I always think about it in the context of AUM, not turnover of active vs passive.
“You only find out who is swimming naked when the tide goes out.“ — Warren Buffett
NoRegret
Posts: 505
Joined: Sat Dec 16, 2017 1:00 am
Location: California

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by NoRegret »

dignan wrote: Wed Feb 19, 2020 11:33 am Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)
https://www.bloomberg.com/news/audio/20 ... et-podcast
Over the last decade or so, we’ve seen an incredible rise in so-called passive investing. While definitions differ over what this means, we’ve seen more and more money poured into index funds (which own every stock in a given basket). Meanwhile, money has been yanked away from money managers who attempt to select individual stocks. One school of thought argues that this is a positive, in part due to lower fees. But is there a dark side? On this week’s episode, we speak to Mike Green of hedge fund Logica Capital, who argues that the trend is causing major market distortions that will eventually unwind with ugly consequences.
I found this podcast very interesting and thought I'd share it for discussion. If fund managers think that passive funds are creating an issue in the market, then why don't they make their active funds more transparent, inexpensive and desirable to invest in?
There are plenty of other podcasts and YouTube videos featuring Mike Green, some of which delve more into his work and strategy. He sees “active to passive” as a secular change that will continue, and is positioned to take advantage of it. I found (what little of) his work on fund flow and market structure compelling.

The arithmetic of active management applies to active managers (stock pickers especially) in the same investment universe, e.g. equities. It doesn’t apply vis-a-vis Samuelson’s dictum (markets can be micro efficient, macro inefficient), and certainly not against a manager like Mike Green who’s using different financial instruments.
Market timer targeting long term cycles -- aiming for several key decisions per asset class per decade
Oregano
Posts: 365
Joined: Fri Nov 22, 2019 8:30 pm

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by Oregano »

Passive investing can have some distortions, but they are much less than claimed by the enemies of passive investing. This year's stock market performance shows pretty clearly that active managers still set prices. Take a look at the linked chart on the impact of the coronavirus on stocks - passive management did not cause these results. Rational active managers adjusted prices and as always, passive managers are just along for the ride.

https://www.isabelnet.com/equity-perfor ... it-rating/
MotoTrojan
Posts: 11259
Joined: Wed Feb 01, 2017 7:39 pm

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by MotoTrojan »

jhfenton wrote: Wed Feb 19, 2020 11:45 am Says a hedge fund manager whose livelihood depends on people avoiding index funds.

Wake me up when 80-90% of the equity market is indexed, and we can have a debate about at what level price discovery would break down.
Given your style-box, would be interesting to hear your thoughts on Logica's view on the value premium...

https://www.logicafunds.com/talking-you ... ut-value-1
https://www.logicafunds.com/talking-you ... ut-value-2
https://www.logicafunds.com/talking-you ... ut-value-3
Forester wrote: Sat Jun 06, 2020 6:44 am Michael Green goes into significantly more detail here, on why he believes passive is distorting the market.

https://www.youtube.com/watch?v=6SVEaK7eDNk
Forester too, as I know you've listened to Green and also are a value believer.
donaldfair71
Posts: 1241
Joined: Wed Mar 06, 2013 3:15 pm

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by donaldfair71 »

Larry Swedroe recently stated in a podcast that he believed that with as few as 500 non-indexers, price discovery would still exist.

https://podcasts.apple.com/us/podcast/w ... 1466669216
User avatar
nisiprius
Advisory Board
Posts: 52215
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by nisiprius »

The retail department store business didn't collapse as a result of John Wanamaker and R. H. Macy putting price tags on thing in the 1870s. Nothing terrible resulted from most customers becoming passive price-takers instead of active price-makers.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
User avatar
Forester
Posts: 2400
Joined: Sat Jan 19, 2019 1:50 pm
Location: UK

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by Forester »

Impact of mass rebalancing? (target date funds?) Also overlaps with end of month pay. Last four corrections ended in the last week of the quarter, on the 23rd;

https://twitter.com/VincentDeluard/stat ... 61440?s=20

Image
Amateur Self-Taught Senior Macro Strategist
User avatar
Harry Livermore
Posts: 1937
Joined: Thu Apr 04, 2019 5:32 am

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by Harry Livermore »

Forester wrote: Sat Jun 06, 2020 6:44 am Michael Green goes into significantly more detail here, on why he believes passive is distorting the market.

https://www.youtube.com/watch?v=6SVEaK7eDNk
Good golly miss molly he REALLY hates passive... there's another half dozen youtube videos in the queue where he's saying the same thing. Why does he care??? It's like he has been personally hurt by indexing.
Cheers
User avatar
PicassoSparks
Posts: 417
Joined: Tue Apr 28, 2020 5:41 am

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by PicassoSparks »

If passive distorts the market then there is an arbitrage opportunity for active investors to take advantage of. If it’s not distorting the market, then the result is there are fewer unskilled investors in the pool, raising the skill bar for active managers to find an opportunity.

I would expect that a skilled active investor would prefer a passive bubble. If they saw one, they’d keep their mouth shut and take their profits.
User avatar
nisiprius
Advisory Board
Posts: 52215
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by nisiprius »

Image

V-shaped? Really?

To me the red line looks "WW"-shaped and the top green line looks "slibber-bumppo"-shaped. Not like the "V" in any alphabet I know.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
langlands
Posts: 1093
Joined: Wed Apr 03, 2019 10:05 pm

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by langlands »

PicassoSparks wrote: Tue Sep 29, 2020 6:32 pm If passive distorts the market then there is an arbitrage opportunity for active investors to take advantage of. If it’s not distorting the market, then the result is there are fewer unskilled investors in the pool, raising the skill bar for active managers to find an opportunity.
Exactly. Active investors make money through two mechanisms: asset gathering and market outperformance. Popularity of passive investing makes asset gathering harder, but market outperformance easier. A manager that depends primarily on management fees because he can't beat the market will naturally be miffed by this. On the other hand:
PicassoSparks wrote: Tue Sep 29, 2020 6:32 pm I would expect that a skilled active investor would prefer a passive bubble. If they saw one, they’d keep their mouth shut and take their profits.
User avatar
Forester
Posts: 2400
Joined: Sat Jan 19, 2019 1:50 pm
Location: UK

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by Forester »

I take issue with the bolded section, it's hard to believe that passive investing required rule changes to take root, the author should develop his case better here. Otherwise he does appear to show increasing correlation among megacap stocks and the increasing strength of the momentum effect. One obvious implication is that momentum may be more of a structural play than a behavioral phenomenon and that it's usefulness as a portfolio tilt could be imperfectly timed to passive reaching it's apex, until that moment arrives, momentum should be exploited.

https://www.logicafunds.com/policy-in-a ... -pandemics
Over the past 25 years, we have experienced unprecedented growth in passive investing. Most Americans and market participants are unaware that this has become the primary mechanism by which investments occur. Regulatory changes, heavily influenced by the lobbying activities of Vanguard and Blackrock, have led to an inexorable flow of capital towards passive investing. Today, more than 100% of gross flows into the stock market are passive (meaning discretionary managers are facing gross redemptions) and nearly 85 cents of every incremental retirement dollar now flow into a target date fund. Roughly half of all 401Ks hold a target date fund as their sole security.

The theory behind passive investing relies on a very simple concept, the Efficient Market Hypothesis, which posits that current prices reflect all available information. As a result, trying to “beat the market” is a fool’s errand and investors should simply try to passively participate. Unfortunately, the assumptions behind passive investing are critical -- no transactions costs, costless information, homogenous expectations, and perfectly rational investors. These do not hold in the real world.

......

There is a key assumption within the articulation that the investor holds the market portfolio. How does the investor get in? Apparently magic. How does the investor get out? This would also be magic. These assumptions were successfully challenged in a 2016 paper by Lasse Pedersen, “Sharpening the Arithmetic of Active Management” where the author noted that changing index construction requires passive participants to trade. Pedersen’s work, however, did not go far enough. As the above flows charts highlights, “passive” investors are forced to trade every single day due to incoming flows. Each new dollar invested into passive index funds must purchase the securities in the benchmark index. These purchases exert an inexorable influence on the underlying securities. Per Sharpe’s own work, these are not passive investors – they are mindless systematic active investors with zero interest in the fundamentals of the securities they purchase.

If incremental investor dollars were increasingly flowing into market capitalization indices, we would expect to see two clear phenomena. First, we would expect to see momentum rewarded as securities that rose in price would capture an increasing fraction of each incremental investment dollar. Second, we would expect to see a rise in correlation as securities become increasingly traded as a group.
Amateur Self-Taught Senior Macro Strategist
invest2bfree
Posts: 1279
Joined: Sun Jan 12, 2020 8:44 am

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by invest2bfree »

Passive is going to drive away inept managers out of the system.
People who complain are the managers like Mike Green who were either taking 2 and 20 without producing any alpha.

Passive is just driving closet indexers out of the game faster.

I do believe that 25% of the active managers beat the market and get extraordinary returns.

If you concentrate enough and have some luck on your side you could have easily beat the market this year.
36% (IRA) - Individual LT Corporate Bonds , 33%(taxable) - schy, 33%(taxable) - SCHD Dividend Growth
User avatar
JoMoney
Posts: 16260
Joined: Tue Jul 23, 2013 5:31 am

Re: Odd Lots: Why Passive Investing Might Be Distorting The Market (Podcast)

Post by JoMoney »

invest2bfree wrote: Sun Oct 04, 2020 10:39 am...
I do believe that 25% of the active managers beat the market and get extraordinary returns...
FWIW, at times even more than 25% of active managers beat "the market" returns, part of the issue though, is there is a lack of consistency among those that do so over time, and over longer time periods the aggregate result is much lower than that. I do believe there are managers who beat the market with skill, but the number of those that do is consistent with that of a random result, and I don't know how to differentiate them in advance.
I believe professional basketball players have skill in their game, but the standings at the end of the season would have a similar looking distribution if they had all flipped coins instead. Even though the results are the same as a random outcome, I don't take that to mean I'm just as likely to rank with them if I tried to compete in their game. It's a bit of a tangent, but I think there is a meaningful distinction in there for those that are passive investors because they think the market is "efficient" vs those that realize the securities markets are a game they don't have an advantage in.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham
Post Reply