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Old 04-09-2015, 12:54 PM   #41
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True, but "the total market" would do worse and worse. Without the discipline of active investors looking for to buy and selling stocks they believe to be overvalued, the prices of equities would get increasingly disconnected from reality. Good young companies with smart ideas would be starved for investment capital and grow very slowly, and inefficient lumbering dinosaurs would continue to have their overly-high stock prices supported by the "auto-buy" indexers. The winners would be private capital and private companies--they'd produce better and better returns compared to the increasingly value-blind, fat public equity market. The companies in the public equity market would have falling dividends while private companies and those funded outside the public equity sphere would produce increasingly attractive returns for their owners.

Be thankful for active investors--but don't feel obligated to join them.
Thanks Samclem, that was my original thinking. As more and more move to index funds the market would become less efficient. Once large numbers catch on to index investing, it would become less productive. At least my thought, I read that on the Internet somewhere, must be true
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Old 04-09-2015, 01:04 PM   #42
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So, if the active stock pickers keep picking the wrong stocks (because they are not even as good as chickens), while the indexers just go along with the flow, why don't buggy whip companies keep getting higher and higher prices over time, while good companies get cheaper and cheaper?

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True, but "the total market" would do worse and worse. Without the discipline of active investors looking for undervalued stocks to buy and selling stocks they believe to be overvalued, the prices of equities would get increasingly disconnected from reality...

Be thankful for active investors--but don't feel obligated to join them.
Drawing the parallel to the political arena, I may just stop voting one of these days. I never bother to actively participate in any political movement, because I rely on different factions to keep each other in balance.
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Old 04-09-2015, 01:20 PM   #43
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So, if the active stock pickers keep picking the wrong stocks (because they are not even as good as chickens), while the indexers just go along with the flow, why don't buggy whip companies keep getting higher and higher prices over time, while good companies get cheaper and cheaper?
The chicken experiment Alan described best models "technical () analysis" (foretelling future based on previous patterns of stock prices), not "fundamental analysis" (based on an assessment of the relative value of securities). To simulate fundamental analysis, the chicken and the human subject would need to be given access to the algorithm that turns each light on.

I believe a sufficiently talented analyst (or team) given sufficiently good information can (and do) spot underpriced and overpriced equities at a greater-than-random rate. But I don't think I can do it, and I don't think I can identify a priori those who can. And, the cost of trying to play the game exceeds the expected value of the results. So, I'll take the better-than-average average via indexing.

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Drawing the parallel to the political arena, I may just stop voting one of these days.
If more people do that, we might get better results. But it depends who stops voting--and, like many other areas, most people think their acumen is "above average".
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Old 04-09-2015, 01:35 PM   #44
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... the cost of trying to play the game exceeds the expected value of the results...
I tend to agree with that.

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... If more people do that, we might get better results. But it depends who stops voting--and, like many other areas, most people think their acumen is "above average".
Yes, if only I could get people who disagree with me to stop going to the poll. Indeed, darn voters keep thinking they are "above average". You can't win.
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Old 04-09-2015, 01:50 PM   #45
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I guess then that it is a fascinating paradox that index investors who are allegedly settling for average more often than not end up with above average performance. How does that happen?
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Simple the fees (either in money or the investors time) are higher for active managment than indexing. Based upon the best fees are at least 10x for actively managed funds than the lowest cost index funds. Now if you are doing the management yourself, how much is your time worth? (I.E. unless you enjoy it you could be doing something else instead)
I was being a bit facetious in my query. While fees are a part of it, poor stock picking by managers and active managed investors tendency to chase past performance also play a part IMO.
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Old 04-09-2015, 01:54 PM   #46
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I was being a bit facetious in my query. While fees are a part of it, poor stock picking by managers and active managed investors tendency to chase past performance also play a part IMO.
Boogle I believe starts with the thesis that over the long term any investment managers performance tends to revert to the mean, partly as happend with the old Fidelity fund, they get so many investors that they are essentially forced to index as they are to big to not affect the market with their investments. So if over the long term the best one can expect is to keep even with the market, then the fees make all the difference.
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Old 04-09-2015, 02:03 PM   #47
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I guess we will just have to wait for the next update in the Buffet bet of the index versus the hedge-fund. So far, it isn't looking good for all the sophisticated people at those hedge funds who try to determine the best places to put their money ('your money'? do they put 'their money' in the funds they sell?).

Looks like this bet might be one of their less than optimal choices?

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Old 04-09-2015, 02:24 PM   #48
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Boogle I believe starts with the thesis that over the long term any investment managers performance tends to revert to the mean, partly as happend with the old Fidelity fund, they get so many investors that they are essentially forced to index as they are to big to not affect the market with their investments. So if over the long term the best one can expect is to keep even with the market, then the fees make all the difference.
Interesting misspelling, and given how respected he is I wouldn't be surprised to see a new verb come into the finance world.

"I don't know which type of asset allocation is better, let me just Boogle that for you".
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Old 04-09-2015, 02:27 PM   #49
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Interesting misspelling, and given how respected he is I wouldn't be surprised to see a new verb come into the finance world.

"I don't know which type of asset allocation is better, let me just Boogle that for you".
And someone could write a theme song, "The Bogle Boogie".

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Old 04-09-2015, 03:17 PM   #50
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Many years ago I read an article about the typical sort of lab rat testing that is done, but this article was titled, "Are chickens better at stock picking than humans?". The test gets right to the heart of why many people do poorly trying to beat the market when they can do better by "being the market" and choosing index funds.

The people undergoing this experiment had no idea they were being tested against chickens and the test went like this:

There are 2 stations that give out rewards (food for the chickens, coins for the humans). Above each station is a light and if the subject is under the light when it comes on then the station delivers the reward. The lights come on randomly but are biased to one particular station. Both chicken and human subjects quickly determine which light comes on most often. Once a chicken realizes which station gives more rewards it stays there for the remaining length of the test. Invariably the human subjects try to beat the odds, see sequences that aren't there and move from station to station to try and get more than by simply staying at the station that gives out more.

Overall, the chickens easily won the contest even though some humans did do better.
That is an interesting experiment and incorporates some of what goes on in the markets. But it misses some things I can think of like (1) momentum effects, (2) the value premium, and (3) the small growth negative premium due to the asset class's lottery like character.
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Old 04-09-2015, 03:25 PM   #51
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That is an interesting experiment and incorporates some of what goes on in the markets. But it misses some things I can think of like (1) momentum effects, (2) the value premium, and (3) the small growth negative premium due to the asset class's lottery like character.
It wasn't actually an experiment on the markets it was an experiment on human behavior which some finance reporter picked up and equated to human behavior in the market when it comes to DIY or index funds.

You could apply the results to other aspects of life.
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Old 04-09-2015, 06:52 PM   #52
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If I keep pushing my idea of "political indexing", and tell people to not bother to vote and just to rely on the political active factions to decide at the poll, will I become a hero for saving John Doe the trouble of trying to figure out the issues, and to see what's right or wrong? Why can't he just accept the "wisdom of the masses"?

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... I am going out on a limb and postulating that many "index investors" think of themselves as above average because they are relying on backtest results that say they are likely to beat the stupid money that trades a lot. I'm not saying they are wrong, just that many index investors do not think of themselves as "just average".

Regarding the OP, there is the whole question of "what index"? There are so many indexes out there. Some people trade indexes. And ETF's are just baskets of stocks, why not flip them? That's what many do. Have you guys heard that biotech is hot? Buy a biotech ETF to protect yourself from individual stock risk.

You can probably tell I'm having fun with this. Please don't take me too seriously (but I'm above average).
Me too! But I do want people to think about what I pointed out.

Now, it is true that many investors trail the indexers. How many people never owned stocks in their life, but scraped up some money to buy dot-com stocks? I still recall around 1998 a story of people gathering up family heirlooms and selling them for the gold content in order to get money to buy stocks.

Indexing gives one a safety margin of diversification. But as Lsbcal points out, there are many indices: growth vs. value, small vs large cap, US vs international, developed vs emerging markets. Most indexing investors still have to decide how to weigh each of the above components. Stock vs. bond vs. cash?

So, indexers like to claim better performance, but which index are they talking about? And over what period?

Now, I agree that the market overall is reasonably efficient and rational. If a stock is priced at a lower or higher P/E than another, there's a reason for it. If you bet against the market, saying that this stock should be priced higher or lower, you would better have a good rationale. And even so, your hypothesis often turns out wrong.

But it causes me to itch when people take this "efficient market" to the extreme, and think that the market is this super-smart entity that can never be wrong. How can one then explain repeated bubbles and crashes? Did you ever allow yourself to question if the market could be wrong during the dot-com era or the more recent real estate bubble? See no evil, hear no evil, talk no evil?

In the political arena, with the "wisdom of the crowd", why did the world have terrible rulers in the past who had the popular support? Currently, Putin has the majority support of his people, despite bringing his country to ruin. The masses are not always right, in stock or in politics.
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Old 04-09-2015, 06:56 PM   #53
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I guess we will just have to wait for the next update in the Buffet bet of the index versus the hedge-fund. So far, it isn't looking good for all the sophisticated people at those hedge funds who try to determine the best places to put their money ('your money'? do they put 'their money' in the funds they sell?).

Looks like this bet might be one of their less than optimal choices?

-ERD50
What about the hedge fund managers that are recently partnering with Warren?
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Old 04-09-2015, 08:14 PM   #54
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We have two different markets involved here, 1 that does not include control of a company by small investors and one where one of the aims is to acquire control of a company. If a companies stock out of wack in a way that a control investor can make money they will get involved. In the case of overvalued stocks the gamblers who like to short stocks will get involved. I suspect that folks who use the market to gamble won't ever go for indexing as the thrill is gone.
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Old 04-09-2015, 08:50 PM   #55
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What about the hedge fund managers that are recently partnering with Warren?
Tell me more.

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Old 04-10-2015, 02:52 PM   #56
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True, but "the total market" would do worse and worse. Without the discipline of active investors looking for undervalued stocks to buy and selling stocks they believe to be overvalued, the prices of equities would get increasingly disconnected from reality. Good young companies with smart ideas would be starved for investment capital and grow very slowly, and inefficient lumbering dinosaurs would continue to have their overly-high stock prices supported by the "auto-buy" indexers. The winners would be private capital and private companies--they'd produce better and better returns compared to the increasingly value-blind, fat public equity market. The companies in the public equity market would have falling dividends while private companies and those funded outside the public equity sphere would produce increasingly attractive returns for their owners.

Be thankful for active investors--but don't feel obligated to join them.
Not certain I wholly agree with this. All the world's equities are not held by passive investors. Active owners hold a significant portion of stock (particularly of those smaller companies). In the ridiculous extreme I agree that if absolutely everyone held passive index investments there wouldn't actually be a market; but, even a small amount of market based trading by other sorts of investors and through M&A/divestitures should lead to "appropriate" pricing. Remember that only a fraction of the shares of any equity routinely trade on a given day. Within the sample space of reality, this isn't a concern IMHO
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Old 04-10-2015, 04:29 PM   #57
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Tell me more.

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Warren Buffet just bought a private placement partial stake into a company Axalta that is primarily owned by Carlyle Group, the group that coined the phrase. He has also partnered with 3G Capital, a private equity group, in buying shares in Heinz/Kraft Foods and the Tim Horton/Burger King deals. These are both companies of the type he has actually criticized as vultures looking for an exit strategy as soon as they purchase.

Most interestingly on the bet, which was actually only 320 thousand, which was the S&P500 would beat the Hedge Fund managers was each side would put the 320 thousand into a zero coupon bond that would then come to the million dollars at the end of ten years. The conservative "sure" zero coupon bond far outperformed both sides of the equity bet the S&P500 and the hedge fund managers so that in 2012 after 4 years into the bet the bonds had each become worth over a million dollars so they sold them and placed the proceeds into Berkshire Hathaway class B stock with Warren personally agreeing to match any shortfall if the value fell below 1 million. Presently that is now worth 1.6 million dollars or the "safe" bet is up 150% from 2008, S&P 500 side of bet is up about 70 percent and hedge fund managers up 20 percent.
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Old 04-10-2015, 05:43 PM   #58
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Warren Buffet just bought a private placement partial stake into a company Axalta that is primarily owned by Carlyle Group, the group that coined the phrase. He has also partnered with 3G Capital, a private equity group, in buying shares in Heinz/Kraft Foods and the Tim Horton/Burger King deals. These are both companies of the type he has actually criticized as vultures looking for an exit strategy as soon as they purchase.
As far as I know 3G Capital doesn't divest. Probably why Buffet teamed up with them. They are still majority owner in Heinz, Kraft, Tim Horton, Burger King and AB/Inbev. So the vulture label doesn't apply. And from my own network I can tell these guys don't raid & dump. They do go in and shake things up seriously, like firing half or more of the senior management. They basically re-invented zero based budgeting as well. Buffet supplies capital, not management. 3G provides that.

Don't know the Axalta story, what I gather from the press release is that Buffet bought the shares from Carlyle shortly after an IPO. So it's not a partnership as with 3G, just a transaction where it's easier to buy directly vs. open market. He might disapprove of Carlyle (don't know), doesn't preclude dealing with them on favorable terms.

[Edit] Just to be precise: 3G Capital isn't a hedge fund, it's a private equity firm that goes hands on with the company. Big difference.
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Old 04-10-2015, 06:12 PM   #59
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I'll take a stab at it. Shares owned by totally passive index funds can be deemed for most purposes as non-participating in the market.

Let's simplify into the extreme at first:
  • Only 2 publicly listed companies, A & B, same profit, same revenue, same business. Perfect clones.
  • Only 10 investors, each have the same amount of money
  • All investors have to choose between one of those companies in any proportion but have to be fully vested at all times.
  • All just want to optimize financial return in the long run.
Let's say you start with all investors actively trading. Then one day everyone wakes up and converts to indexing.

What happens is that all trading will stop, and prices will stay the same forever, regardless of company performance. Probably A & B will have roughly the same market cap given their start situation.

... some years later company B doubles its profits, A stays the same.

One investor wakes up and says, B should be worth double. He wants to buy B shares and sell A shares .. but there is no-one to buy it from! The market is illiquid. Another investor wakes and thinks the same ... no difference. Still no-one to sell A to, no-one to buy B from.

In fact, it takes an investor with an active opinion (say #3) that believes B is actually worth less than double, and A worth more the original price to get a transaction going.

This shows that for purposes of relative price setting you only need a handful of traders to agree on price. The degree to which those traders differ in their valuation of both companies determines volatility, nothing else. So you can have >90% of the market being indexed, makes no difference. It also doesn't have any direct impact on volatility.

What happens to the indexer? basically nothing. if A goes down and B goes up by shifting capital, it doesn't make any difference as long as he holds his own position. In fact, his return has nothing to do with the relative prices of A vs. B. His return comes strictly from dividends paid out by both companies.

Going further things are of course not that simple.

But what does remain in my view is that there seems to be nothing inherently true that a large passive indexing market has to be less efficient.

It may even become more efficient, as only the very best qualified active traders remain in the market and competition among them becomes ever more intense.

Just my two cents.
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Old 04-10-2015, 06:17 PM   #60
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Your point is well taken... the results of index investing is not 'average'.... it is 'above average'.... IOW, people who invest in managed funds do worse... some a lot worse... so if you take 100 people and the index investor beats 90 people who invest in managed funds, that is not 'average'....

By definition, index investing does the average less the index expense. But doing slightly less than average, a C-, looks pretty good when most everyone else is flunking.


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