Interesting comment about passive “danger”

[Steveam]

From today’s FT:

“We’ve seen an AI frenzy, the retail bandwagon getting going and an expansion of valuations around the potential of those hyperscalers in the US,” says Noffke. “The US market is as concentrated as it’s ever been. After a period of concentration you usually get a broadening. This looks to be quite an unusual phenomenon. But they’re great companies, and it’s difficult to knock them.”

The concentration risk should worry index investors, says Edelsten. “The Magnificent Seven is now 26 per cent of all global equities. And they’re correlated. Financial advisers often say the index is a low risk, worth investing in. It isn’t when the index itself is very wobbly. Back in 1987 the global index was 50 per cent in Japan — another point when it clearly wasn’t very balanced.”

For various reason, nothing to do with skill, I avoided the Japan collapse but I had several friends who were heavy Japan and lost fortunes.

Best wishes, Steve

[Urbandreamer]

There is very little new in this.

I remember when the FTSE 100 was very heavily represented by two companies that did the same thing! Over 15% of the FTSE 100 was those two oil companies. The same things were said back then.

Now if you adopt a diversified portfolio with other assets, I.E mix UK and US trackers yourself and maybe add bonds, possibly you can give up actually thinking. However market weighted indexes will ALWAYS concentrate in areas that previously did well. It's the nature of what they are.

Hence currently a global index tracker is heavily weighted to the US. A US tracker to Apple et-al. If you want to avoid that then you will have to think and make choices.

[JohnB]

The broader the fund, the more work the fund managers do to re-balance to keep it a "bit of everything", sampling so its not literally everything.

It seems easier to let them do it than adjust a range of funds following particular indexes manually.

[DrFfybes]

However market weighted indexes will ALWAYS concentrate in areas that previously did well. It's the nature of what they are.

The flipside of this is that a market tracker would have held those megaliths when they were minnows and enjoyed their growth.

[Urbandreamer]

However market weighted indexes will ALWAYS concentrate in areas that previously did well. It's the nature of what they are.

The flipside of this is that a market tracker would have held those megaliths when they were minnows and enjoyed their growth.

No!
That's the flipside to losses. It says nothing about risk.

From the OP's quote.

Financial advisers often say the index is a low risk, worth investing in.

The risk increases as the index becomes more concentrated. Arguably this is the large companies getting larger, though it could equally be due to the small companies getting smaller. However neither change the fact that you are becoming more dependent upon a few given companies.

The flipside is that risk reduces as those large companies stop growing and other companies in the index grow.

[GeoffF100]

The global leaders come and go, but we do not know which companies will grow and we do not know which companies will shrink. That does not matter if we own everything. We will own both the growers and the shrinkers. Apple has a huge market capitalisation because it has huge sales and makes a huge margin on those sales. If Apple were split, that would not reduce the market risk. The giant fund managers of this world have no choice but to stay close to market weight. If they tried to weight more equally, the Apples would be hugely under priced and the corner shops would be hugely over priced.

[Bubblesofearth]

The global leaders come and go, but we do not know which companies will grow and we do not know which companies will shrink. That does not matter if we own everything. We will own both the growers and the shrinkers. Apple has a huge market capitalisation because it has huge sales and makes a huge margin on those sales. If Apple were split, that would not reduce the market risk. The giant fund managers of this world have no choice but to stay close to market weight. If they tried to weight more equally, the Apples would be hugely under priced and the corner shops would be hugely over priced.

Which is why private investors can steal a march on the market by equal weighting

BoE

[Urbandreamer]

The global leaders come and go, but we do not know which companies will grow and we do not know which companies will shrink. That does not matter if we own everything. We will own both the growers and the shrinkers. Apple has a huge market capitalisation because it has huge sales and makes a huge margin on those sales. If Apple were split, that would not reduce the market risk. The giant fund managers of this world have no choice but to stay close to market weight. If they tried to weight more equally, the Apples would be hugely under priced and the corner shops would be hugely over priced.

And again the point made is performance. Can we agree that you may get better performance with a concentrated portfolio?
That it may in fact make sense to invest in companies that have a history of doing well?

That is NOT the point about the concept of risk. I happen to chose to be an active investor and have often taken significant risks. Have I out performed the market? NO I HAVE NOT!

Does that mean that market weighted indices, are risk free? Or low risk,? Or indeed that the risk of indices doesn't change?

While I have admitted to taking risks, does the fact mean that I ignore risks? Or does it mean that I consider them and possibly under performance may be a price worth paying for some?

BTW, you never own "everything", as has been pointed out! It's simply too expensive to own "everything". This is one of the main causes of tracking error. Sure, eventually you buy in, or rather someone does it for you. But don't make the mistake of thinking that you owned "everything".

Then there is a question of which index you follow. There are ones with different remits. For example limiting constituents to 5% of the index. What does that do to your concept?

I could ask if choosing an index with such limits rather than one without is an active choice... but the answer is obvious.
At some point an investor has to pony up an put their money down. What they can't actually ever do is buy everything.

PS for the record I oppose the idea that some outside force, AKA the government, should decide that a company, like Apple is too big. That should be up to people buying their products or those who own the company.

[Alaric]

At some point an investor has to pony up an put their money down. What they can't actually ever do is buy everything.

Funds that attempt to track an index have at least two methods of doing so. One is sampling where they reduce the number of separate holdings by grouping together Companies they expect to have similar performance and just choosing one. Another is full replication, where they hold shares in direct proportion to their index content.

The larger the fund, the lower the count of constituents in the index being tracked and the more liquid the index contents the more likely it is that a full replication strategy will be followed.

This is what Vanguard have to say
https://www.vanguard.co.uk/professional ... management

[GeoffF100]

Does that mean that market weighted indices, are risk free? Or low risk,? Or indeed that the risk of indices doesn't change?

Of course not. The risk certainly changes too.

BTW, you never own "everything", as has been pointed out! It's simply too expensive to own "everything". This is one of the main causes of tracking error. Sure, eventually you buy in, or rather someone does it for you. But don't make the mistake of thinking that you owned "everything".

The simplified story is that financial theory says own everything in its market weight ("the market portfolio"), but there are practical constraints. Not everything is tradable economically, or even at all.

Then there is a question of which index you follow. There are ones with different remits. For example limiting constituents to 5% of the index. What does that do to your concept?

Avoid the ones with different remits is the theoretical answer. It may not matter much in practice though, and may even even work in your favour over some period of time.

[Urbandreamer]

BTW, you never own "everything", as has been pointed out! It's simply too expensive to own "everything". This is one of the main causes of tracking error. Sure, eventually you buy in, or rather someone does it for you. But don't make the mistake of thinking that you owned "everything".

The simplified story is that financial theory says own everything in its market weight ("the market portfolio"), but there are practical constraints. Not everything is tradable economically, or even at all.

Well we have to disagree. You can't "own" everything. And in what proportion? Own the market? What market? Ignore, for example, property?

Now property happens to be my blind spot. I'm crap at it. But do you claim that the stock market covers that in your "everything"?
What of for example crypto? As others know I like bitcoin, but not other crypto's. Do you own any in your "everything"?

As for "market weight" well, yes it IS ONE THEORY. That said it can expose you to the likes of the "nifty fifty".
https://en.wikipedia.org/wiki/Nifty_Fifty

Of course not through choice.
Then again, as I thought that maybe I have indicated, the risks will reduce as they are realized.
I.E as the likes of the nifty fifty loose value.

Look I didn't want to argue against passive investing upon the passive investing board.
HOWEVER, when the entire concept of the thread points out that there are issues or risk, can I help but agree that there ARE issues and risks?

[CliffEdge]

Every now and again the financial system blows up. Will the numbers on my screen, or on bits of paper I occasionally receive, mean anything after the next blow up?

Or will I be a pauper?

[GeoffF100]

Well we have to disagree. You can't "own" everything. And in what proportion? Own the market? What market? Ignore, for example, property?

Now property happens to be my blind spot. I'm crap at it. But do you claim that the stock market covers that in your "everything"?
What of for example crypto? As others know I like bitcoin, but not other crypto's. Do you own any in your "everything"?

As for "market weight" well, yes it IS ONE THEORY. That said it can expose you to the likes of the "nifty fifty".

This is not simple. Several Nobel prizes have been won for this work. The theoretical market portfolio includes all financial assets in their market weights. That certainly includes property. It does not include bets on horses or bitcoin. There are practical constraints as I have said. Nonetheless, we are only interested in part of the market portfolio here. That of liquid stocks in well regulated markets. A cheap market weighted tracker does nicely there.

[Urbandreamer]

Every now and again the financial system blows up. Will the numbers on my screen, or on bits of paper I occasionally receive, mean anything after the next blow up?

Or will I be a pauper?

Please don't read the book "When money dies" (1975).
It's truly depressing.

Or do, and take lessons.

For those who have not a clue, it's a history book. Nothing to do with investing. Or investing today. Of course we could question how "normal" today is, or what the future holds.

It's particularly depressing to read the journals of a rich lady, who was a patriot and trusted her country. She became a pauper in a short time.

But I digress. Passive investment is about being passive.....
Err....
Don't read the book!

I'm going to ignore GeofF's comments, as he is simply wrong in his assumption that there are no other assets than the stock market. I don't own any Weetabix (not quoted), nor is gold part of the stock market.

For that matter we should ignore his comments upon bitcoin, other than to accept that he doesn't like it and notes that, just like many other things, it's not part of the stock market.

Ps, I believe that most property is also privately held, so he is wrong there as well. Or at least my home is not on the stock market. Possibly his is.

[GeoffF100]

I'm going to ignore GeofF's comments, as he is simply wrong in his assumption that there are no other assets than the stock market.

I have not written that. That is something that you have made up or misunderstood. Here are Nobel Prize winning economists telling you to buy a tracker:

https://www.youtube.com/watch?v=SwkjqGd8NC4