Do passive investments distort valuations?

[BreathFree]

I tried a search here but could not find any threads that addresses distorted valuations in passive funds or etfs and any potentially negative outcomes.

I found a few articles online. Here is one:

http://mobile.nytimes.com/2015/10/11/business/mutfund/the-ease-of-index-funds-comes-with-risk.html

Should we be concerned about this? I've read this issue is active investors' argument against passive investment.

I'm a passive investor, my domestic stock allocation consists mostly of SPY and VTSMX.

 

[pb4uski]

Not concerning to me.

 

[eta2020]

I'm a passive investor, my domestic stock allocation consists mostly of SPY and VTSMX.

No you are fine. Don't worry be happy. Just like rest of investors in VTSMX with 464 Billion dollars in assets.

If that fund underperforms unmanaged portion of Fund that means 99% of US Market will underperform 1% that is not in this Index.

I quote article: "Professor Finke suggests, index stocks will become ever more overvalued and that fact will finally be broadly recognized. The eventual result? “They will underperform,” he predicted, suggesting a shift by investors to non-index stocks."

 

[Totoro]

If anything, the article is an argument in favor of indexing. A narrow index is the issue described. If a narrow index gets too popular with no underlying merits, it will underperform. That's the same issue with stock picking.

A total index, by definition, tracks the total stockmarket. No such risk there.

The argument is here specifically for the S&P 500 being a too narrow index and as a consequence being overvalued. That's a reasonably silly one if you look at VTI - the total american market - vs. S&P 500, they are practically twins with VTI actually outperforming a little bit vs. the S&P 500, about 0.5% per year.

One can argue that the american market is too hotly valued vs. the rest of the world, since VT has lagged VTI by quite a bit and various multiples point to a higher US stock valuation. Which is one of the reasons I simply buy VT - that's the whole world. I may be wrong, but I won't be more wrong than the average investor on this planet.

 

[Koolau]

You might make a case for this issue "becoming" a problem in the future, but underperformance is already a fact for many of the managed funds - and they charge you more for the "privilege" of their underperformance. At least if a passive fund underperforms, it shouldn't cost much to do so. Seriously, I'm not concerned about it in the short run (10 years??) Long run - we're all dead. YMMV

 

[BreathFree]

OK. Great. Thanks for the replies. I wasn't so much worried about passive investing in general, but concerned one index fund may be better than another for the reasons mentioned. My 401k only offers SPY, but I am purchasing VTSMX in my personal nonretirement account.

 

[meierlde]

The total market funds include small caps, so if you think small caps will do better than large caps go there, the S&P 500 make up 75% of a total us stock market fund. This article provides a chart that shows the performance of the Vanguard versions of the two types of fund:S&P 500 vs. Total Stock Market: Which Is Right for You?
Some years one type does better and then in other years the other type does better. The total fund tends to have higher volatility however. Of course if your also willing to add currency risks to the mix then something like Vanguards Total World stock market VT as an etf or VTWSX as a mutual fund, might make sense. Although it would be interesting to see a 116 year chart of what such a hypothetical fund might have performed like, likely ot took a bat 1914 1922 and 1929-1949.