There are strategies with some academic support for outperforming the S&P 500 based on anticipating changes to the composition of the index. The problem is that implementing the strategies might cost a lot. The real question is whether a stockpicker can do better than the market once you factor in management fees, trading costs and taxes. My belief is that active managers don’t do so reliably now. If more people index, it will probably get easier for active managers to do so but right now, few actively-managed funds outperform comparable index funds in any given year. Generally, even if a fund outperforms an index in one year, it’s not terribly more likely to outperform that index the next year than any other fund.
Not really. The index fund doesn’t buy or sell shares based on changes in prices of its underlying stock. If Apple shares drop in price, Apple will represent a smaller share of the index but the lower price also means that the Apple shares that the fund holds will be worth less. These factors balance automatically with market cap weighted indexes like the S&P 500. The fund doesn’t trade due to changes in the prices of its securities. It does trade when investors add money or remove money, or when the components of the index change.
IMHO, broader index funds are a better idea than S&P 500 funds. There is no fund that truly tracks everything in the market. It’s hard to even define the edges of “the market” so I don’t think any such fund is coming.
Funny thing though - I’ve gotten lots of proxy cards and not once was a voting item “Do we lower our prices?” That really is not the level of decision being made by shareholders voting.
The level of decision in proxy fights are things like electing or not electing independent directors and support or non-support of various activist campaigns. They are about governance, not prices.
And oddly enough companies with more passive ownership are more likely to have more independent directors and “more likely to be targets of activist campaigns to replace board members.”
OTOH the big index funds are NOT likely to support activist campaigns designed to boost a stock price in the short term (usually involving things like raising dividends, share buybacks, and spinning off divisions). An active manager will. They can flip the stock after the short term bump and not give a hoot about what it does to the company long term. There is potentially a salubrious impact to the index funds in preventing this corporate short-termism. This could be seen in last years Trian Fund proxy fight where those items where the list of demands. It lost because the index funds would not support it. Funny enough currently Dupont is up about the same since right after that proxy fight as the S&P; Monsanto is down 10%.
Anyone able to point me to where to answer this question?
During the last several drops what fraction of investors in index funds pulled out into cash compared to those who stayed pat through the complete down and back up cycle in comparison to the market as a whole.
I am hypothesizing that larger amounts of index fund investing provides some relative stability to the market as those funds will not move more into cash as a matter of policy and attract a population of long term holders, while active managers are more likely to move cash out and into the market as they try to time the peaks and valleys.
I don’t think that’s answerable. You’ve left out a third possibility: abandoning the index to move into other investments perceived as less exposed to the market. Bond funds, bonds themselves, counter-cyclical derivatives and so forth.
I’d be very surprised if anyone could provide a good, reliable answer to that question.
Well I don’t know how to answer it fer sure, but not sure it is unanswerable. I’d count pulling out as the market goes down to move other investments along with it. I wouldn’t count routine rebalancing, but that would likely result to net money into stock index funds as the markets crashed.
The information I am looking for is time serialized tracking of money flow into and out of the index funds in comparison to money flowing in and out of the domestic stock market overall and in particular in actively managed funds. If it flows to and from cash or bonds or other I care not, all of 'em.
Boy, that’d be a chore. And I still think unanswerable in the long run. There are, what, 90,000 or so equities on the big boards? You’d need to try to get info on flows out of indexes - not so simple with so many spread across some many different fund managers - as well as flows into managed funds, equities, and so forth. Just getting all those people to report would be a chore. Some of that info is proprietary if we’re talking hedge funds and such.
I guess it’s achievable, sure. But I wouldn’t want to try to do it.
Nah. I’ve got to find someone else who’s done the work. See figures 1 to 6.
Now interestingly this is an article that highlights the claim that “When markets eventually reverse, the correction becomes deeper and volatility rises as money flows away from passive funds back towards active managers who tend to outperform in periods of weak market performance” but the graphs they present support the opposite contention.
During the 2008 crash and its immediate aftermath net flow dropped in active funds and increased in passive ones, particularly in the equity markets. Hedge funds most of all saw negative flow during and after that crash.
What this does not capture is if the active managers moved what they had left more out of equities and into defensive positions as their equities were losing value or not. minimally however they had to sell off rather than buy during the downturn in comparison to the index fund market.
It’s naive to imagine that shareholders’ and directors’ influence applies only to the specific questions upon which they vote.
Moreover, it’s naive to assume that reading a short excerpt made to emphasize a specific point eliminates the need to read a cited article — obviously you didn’t read the essay I linked to, or you’d be arguing with its author, not me.
[QUOTE=Einer Elhauge, Petrie Professor of Law, in the linked essay]
Although this anticompetitive effect also does not require communication between managers and shareholders, I show below that institutional investors usually do communicate with and actively seek to influence the corporations in which they own shares. In those investor-manager communications, “high on the list of topics” is urging those corporations to “throw the switch from developing market share to instead exercise market power to get margins up” in particular markets, according to the former legal counsel of a very large asset management firm.
However, such active communication is unnecessary for horizontal shareholdings to have anticompetitive effects.
[/QUOTE]
I didn’t read the entire 51-page essay, but early on a specific proxy fight is discussed — the only large shareholder (itself also a fund) of DuPont which was NOT also a large shareholder in Monsanto pointed out to fellow shareholders that their corporation was not maximizing its value. The proxy fight was defeated by Du Pont’s largest shareholders (Vanguard, BlackRock, State Street, and Capital Research) which owned a similar portion (20%), and twice the value, of Monsanto stock.
I think that perhaps I read more of that essay than you did.
If you can find where in that long bit he demonstrated other than quoting someone who like him makes an unsubstantiated statement that such is the nature of the communication, I’ll be grateful. Meanwhile what I do find is his stating that “evidence that institutional investors are directing corporate managers not to compete on price” would be well covered under existing antitrust laws but, he argues, the current absence of such evidence still leaves other remedies that should, he thinks, be pursued.
Did you even skip to the last several pages? His bottom line? There is not a problem now but there could, “at some point”, be one “in the future”, so be worried. When that time comes something will have to be done!
And if the horizontally invested funds voted to protect their larger Monsanto holdings from DuPont behaving competitively in the same space they did a lousy job of it. DuPont has gone up in value substantially in the time since that vote while Monsanto has lost value. DuPont clearly causing problems for Monsanto by teaming up with Dow to better compete with Monsanto and Syngenta, something that was unlikely to have happened if the short-termism of the proxy fight had gone through.
Referring again to the article linked in OP, index funds are just part of a more general “problem.” As the article explains, active managers often need to mimic indexing. Moreover, well-diversified funds will accumulate “horizontally,” especially when the several funds of one fund management company are summed together. This is shown in Elhauge’s essay: 80% of the S&P 500 is owned by institutional investors, though only perhaps 20% of that is held by index or very index-like funds. When index and non-index funds managed by a large company are summed, 20% of both Du Pont and its major competitor are owned by just four managers.
The huge power of these diversified fund companies on the economy is a different issue than the impact of index funds on the stock market, but these issues are closely related. The latter might be considered part of the scope of the more general issue.
You overlook two key points. In the section you quote he’s speaking of index funds and legal antitrust worries. When he writes “not a problem now” he’s discussing threshold for DoJ prosecution, not effect on the economy.
But more importantly, that section is referring to index funds specifically. As I just wrote, index funds are only the extreme form of the more general phenomenon of horizontal accumulations by large diversified institutions.
It must be comfortable to just assume everything he writes is biased! No need to find a scholar who argues against the scholar whose conclusions you dislike — just dismiss them outright!
You can download one of the papers he cites here. This paper goes into great detail about its methodology and concludes “The panel-IV estimates indicate at least 10% higher ticket prices due to common ownership, compared to a world in which firms are separately owned or in which firms ignored their owners’ anti-competitive incentives.” Your $220 plane ticket would cost only $200 without this anti-competitive horizontal shareholding power. Doesn’t that seem significant? Plane tickets are just one example — the entire S&P 500 is subject to these horizontal accumulations.
I am indeed very comfortable with my position of not assuming that something is so just because someone says it is, of requiring evidence before I accept a statement as true.
I readily admit my bias to be skeptical when a paper begins with phrase of “exposing” an “Economic blockbuster” and in the introduction claims that a paper shows a general hypothesis to be true. I am not an economist and while the paper seems to me to be a bit of correlation (in one market) equals causation, I am quite willing to defer to a clear consensus among experts when such exists in areas that are far outside my depth. Azar et al’s paper (your link did not work for me but I found it here, strangely not actually ever published in a journal) itself presents the findings as something they hope will “start the debate.”
Yes it is easy to find serious sources that have major criticisms of the Azar paper and its conclusions.
Personally I would be more convinced if they were able to demonstrate that there has been less competition by price correlated with increasing horizontal ownership (primarily by index funds, as measured by what they call MHHI) across industries. IOW, have anti-competitive practices significantly increased (pricing and otherwise) in some time-correlated manner as index funds have increased their share of ownership in Apple/Microsoft, CVS/RiteAide/Walgreens, DuPont/Monsanto/Syngenta, the big telcoms and entertainments companies, etc.
That said it might be true that index-funds’ horizontal ownership across sectors facilitate the ability of companies to avoid price wars. Maybe. I could be convinced. And if so then deciding what to do about it would be interesting. Limiting the total size of the passive index-linked investment world no matter how demand there is for the product? Forbidding index funds from voting on governance or expressing opinions about how companies are managed, and thereby having no meaningful oversight? Neither seem wise.
Blaming rising wealth inequality since the '80s on the rise of funds that diversify within sectors being accessible to the common investor (most notably albeit not exclusively by way of index fund investment vehicles) seems misplaced to me.
There are two aspects IMO to this issue that are somewhat separate.
The market dynamics of stock trading and price discovery. Here I think anti-index alarmists get way ahead of themselves to put it kindly, are just full of it to be more blunt. ‘Institutions’ does not yet anywhere near equal ‘index mutual funds and ETF’s’. The idea that the huge proliferation of market players like hedge funds, not to mention other ‘institutions’ which are not passive investors, would ignore price discrepancies just because there are ‘a lot’ of index fund money is non plausible. The % of indexed assets would have to be way higher than it is for the markets to just drift away from fair value because of indexing, and that in itself would generate new trading and active management activity.
That whole line of argument is IMO firstly often inconsistent with same members of the general public who complain how too many bright people go to work for WS rather than more ‘productive’ activities. Yet somehow this distorted application of too much talent to the markets would not realize the mispricings. And second I think the presentation of that argument is partly a gullible financial media becoming the mouthpieces of low value added active managers who don’t like index funds because they put pressure on their fees. Yes it is a bad deal to pay a manager a 1% expense ratio if he or she tends to ‘closet index’. But the easy micro solution from investor POV is simply buy a .05% ER index fund/ETF.
The effect of indexing on corporate governance. This IMO has some potential validity as an issue in the here and now and not just in the implausible case ‘everyone’ indexed. As has been pointed out, index fund managers as investors only have an interest in shareholder activism from a ‘good citizen’ POV. They are by definition also invested in competitors simply according to the size of the competitors (as measured by market capitalization of the respective stocks). They haven’t tried to pick a winner among similar companies so don’t have the same direct financial stake in shareholder activism to make that company a winner as do high profile activist investors (Icahn, Ackman etc).
However again to the extent this problem grows, the opportunities for activists increases. And again there’s potential for self contradiction in complaining about concentration of wealth yet ignoring the fact it creates more big individual activists (or at least ones overseeing megabucks of their own in their hedge funds beside outside money). Also, anti-competitive environments still require concentration in the companies themselves. Investor relations dynamics aren’t going to prevent managers looking out for their own interests from competing fiercely if there are dozens of competitors (like small drillers say, and the fact that BP and Exxon are much bigger than they is not very relevant to them, not really the same type of company). If there are only 2 or 3 big companies dominating a business then the indirect effects of also only a few dominant investors might compound the anti-competitive problem…but it’s there to begin with, due to only 2,3 companies.
Also the example given in one of the articles again suggests the issue of perspective. From the consuming public’s POV higher airfares are generally bad and lower ones generally good, assuming excellent safety in either case, which has been the case. From investors’ POV the chronic lack of profitability and serial bankruptcies of the US airlines for a long time was the bad thing. Higher fares are inevitably one of the solutions to that. Often there are general discussions of investing where the implicit assumption is that investor and consumer interests are the same, but they’re not, even if millions of people are both things.
This article reminded me of this thread, so I thought I’d post it here. It doesn’t say much that hasn’t already been covered by the discussion above though I think it’s a good discussion of the issue.
It does seem like the recent discussion around the macroeconomic effects of index funds is that they are bad for consumers. Ironically, if the research is right, index investing is bad for consumers because it creates effective oligopolies that push up prices. Oligopolies are good for shareholders though, and by extension, for index fund shareholders who hold stock in these companies. The study criticizes index funds but only because they might be too good at creating value for index fund investors at the expense of consumers. As an index fund investor and a consumer, I am ambivalent on whether index funds are net good or bad. As an investor, I’m sticking with index funds.
You can of course make the same argument about wage levels.
High wages are great. When I get them and you don’t, so your wages don’t push up the prices I have to pay.
Equivalently, people flocking to low-priced products and low-priced vendors pretty well squeezed out the good paying jobs making those products and working at those vendors.
As long as people in general look at only one end of the telescope when thinking of this stuff, they’re going to be somewhere between myopic and self-defeating. Doesn’t matter if we’re talking wages, investment strategies, or something else.
Interesting article. This bit struck me - yet another facet to the inequality equation.
I am happy to see “much richer bankers” suffer a bit but it seems that instead of them actively preying on the poor, the upper-middle class is doing it passively…
