should be mandatory reading for everyone interested in finance

[OhNoNotimAgain]

And yet, the nearly free, “dumb” index fund prevailed, returning 126 per cent over the decade, while the hedge funds made a more modest 36 per cent.


https://www.ft.com/content/807909e2-032 ... 4d49afbbe3

[TUK020]

behind a firewall.
Do you have a headline to search on?

[Itsallaguess]

Behind a firewall.

Do you have a headline to search on?

Put this into Google, including the quotes -

"Passive attack: the story of a Wall Street revolution"

The accessible FT story should be there at the top of the list.

Cheers,

Itsallaguess

[Dod101]

Thanks Itsallaguess. Your suggestion works fine.

On the subject. I am not sure it needs to be mandatory reading for everyone, and anyway there must be a finite limit to passive investing because they are simply piggybacking the active investors who are after all creating the market in the first place. If everyone was a passive investor........ there would not be a market and the world would be a pretty dull place. It would also disconnect between a shareholder as an owner.

The only reason this should be mandatory reading is so that we can all improve our education. I think the death of the active investor has been greatly exaggerated although it is of course true that many active fund managers do not succeed every year. How could they, except at the expense of others?

Dod

[johnhemming]

there must be a finite limit to passive investing because they are simply piggybacking the active investors who are after all creating the market in the first place.

Market momentum and index funds are all aspects that are not directly connected to the underlying value in securities. Hence there is a point at which they can go haywire.

However, they can go a long way before going haywire. The challenge for an active investor or contrarian is where possible to surf the wave of momentum without forgetting where the sand is. I tend to stick to value investing, but have from time to time benefited from selling into momentum.

[Dod101]

I suspect that we have all of us probably benefited from momentum investing over the years. 'Jumping on bandwagons' and suchlike come to mind. The thing is to know when to jump off (remembering where the sand is, as johnhemming has said).

Index investing surely has a place in the investment universe, and probably for quite a few 'dorises' actually but must surely be self limiting.

Dod

[colin]

Dod101 wrote
Index investing surely has a place in the investment universe, and probably for quite a few 'dorises' actually but must surely be self limiting.

Well i am certainly a 'doris' and would not trust myself with individual company stocks. If by self limiting you mean that as more people become invested in index funds then the potential return for active managers who make the right calls becomes greater then yes I agree , but that does not make it any easier to pick the above average managers .

there must be a finite limit to passive investing because they are simply piggybacking the active investors who are after all creating the market in the first place.

Sounds like a great plan to me , buy the performance of active investors for a fraction of their fees and guarantee outperforming them, it's simple logic. Or should we feel sympathy that index investors are appropriating all their hard work and not paying them? Can't say that my eyes are moist on their behalf.

If everyone was a passive investor........

Never going to happen any more than the idea that everyone is going to go for a drink in the Rose and Crown on New Years Eve .
Yes the FT article should be mandatory reading for anyone involved in financial markets, I really can't see why anyone would disagree unless they have a fear of investment strategies based on real world evidence.

[everhopeful]

I certainly enjoyed reading the article and was educated by it (the Saturday FT is always a good read). Even though I know I would have a more sensible portfolio if it was all in trackers I still like to hold shares and ITs and fixed interest as well as ETFs. It is like knowing that drinking hardly any alcohol would be good for my health but still enjoying that bottle of wine.

[Steveam]

I’m entirely convinced by these arguments but ...

- if one were buying a world index tracker when Japan was at its peak
- if one were buying a world tracker when tech was at its peak

I have some regional or subject matter biases and although the bulk is in trackers of one sort and another there is enough flexibility for me to indulge in being wrong.

Best wishes,

Steve

[OhNoNotimAgain]

Thanks Itsallaguess. Your suggestion works fine.

On the subject. I am not sure it needs to be mandatory reading for everyone, and anyway there must be a finite limit to passive investing because they are simply piggybacking the active investors who are after all creating the market in the first place. If everyone was a passive investor........ there would not be a market and the world would be a pretty dull place. It would also disconnect between a shareholder as an owner.

The only reason this should be mandatory reading is so that we can all improve our education. I think the death of the active investor has been greatly exaggerated although it is of course true that many active fund managers do not succeed every year. How could they, except at the expense of others?

Dod

There will always be people like Odyseus 2000 who are willing to commit risk capital to aid the price discovery process.

[colin]

Cap weighted indexes can only hold the shares that active investors have bought. Quite simple really.

[tjh290633]

Cap weighted indexes can only hold the shares that active investors have bought. Quite simple really.

Funny. I thought they bought all the shares in the index, whether investors have bought or sold them.

TJH

[WorkShy]

I see nothing wrong with passive investing, but with some caveats. For example, I have nearly all my equity exposure in regional passive trackers but I don't use world equity trackers since I want to overweight/underweight certain regions. For example, I don't want any passive EM equity exposure in my portfolio as I obtain a better risk-adjusted returns holding EM bond debt.

I'm cautious about using passive trackers for debt markets or illiquid markets. Take for example, high yield (junk) corporate bond trackers. These are market-cap weighted. The clear problem here is that as the company issues more and more debt, it's weighting in the index will increase. This may well be correlated with increased default probabilities. So it makes no sense in debt indices for them to be pure market cap weighted; there needs to be a cap placed to reduce this risk. In the 1990s, active global government bond managers easily outperformed indices (and early passive funds) due to this effect, generating information ratios of 0.5. Global government bond indices became increasingly overweighted with Japanese JGBs, and managers outperformed simply by underweighting these in their active portfolios.

As for the comparison between the S&P and hedge funds, this misses the point entirely. I have a considerable number of alternative investments in my portfolio, including hedge funds. I want a portfolio that acts like a university endownment; absolute return of CPI+3-4%, very low vol/drawdown, high Sharpe and low correlation with major asset classes. The whole point is for them to generate a consistent absolute return (high single digit) with minimal drawdowns and no correlation with the S&P500. Comparing HFs with an S&500 tracker is comparing apples with oranges.

[colin]

There will always be people like Odyseus 2000 who are willing to commit risk capital to aid the price discovery process.

Yes and when they are right they will be rewarded, it may be that buying index trackers will in the longer term make markets more efficient as the less able fund managers lose their jobs when they consistently under perform.Roger Bootle of capital Economics suggested in one of his books that index trackers would result in fewer but more able fund managers who will be feted like star football players, in a sense perhaps index trackers are the whip keeping active managers on top of their game .

[colin]

tjh290633 wrote
Funny. I thought they bought all the shares in the index, whether investors have bought or sold them.

It should go without saying that if investors do not buy shares in a company then that company will not be included in the index, how else do you suppose the constituents of a cap weighted index get into the index in the first place?

[tjh290633]

tjh290633 wrote
Funny. I thought they bought all the shares in the index, whether investors have bought or sold them.

It should go without saying that if investors do not buy shares in a company then that company will not be included in the index, how else do you suppose the constituents of a cap weighted index get into the index in the first place?

When a company floats on the stock exchange, the issue of shares is underwritten by Investment Banks and other institutions. If the market does not take up the offer, the underwriters take the shares and dispose of them in the market at whatever the market price is.

That's how the shares get on the market, which then decided the price of them. If the capital value is right, they get into the index. They can be bought or sold. Buying and selling does not determine how the shares get into the index, only the price.

You have some strange ideas.

TJH

[Lootman]

- if one were buying a world index tracker when Japan was at its peak
- if one were buying a world tracker when tech was at its peak

Yes, but you would also have bought other sectors and countries when they were at their nadir. That's the point really - you own everything and so obtain a market neutral outcome, rather than making bets and second guessing the market in the hope that you have an information advantage over the sum total of other market participants.

[OhNoNotimAgain]

Comparing HFs with an S&500 tracker is comparing apples with oranges.

Not at all.

In the same way that they are both fruits, trackers and hedge funds both invest in capital markets.

When you think of how much time hedge fund managers would have devoted to meetings, spreadsheets, conference calls and notes over ten years it is self evidently not a good use of resources.

The exercise demonstrated that higher capital returns can be generated for less risk and lower cost by trackers than hedge funds.

The problem is that hedge funds employ more people and support a massive food chain of brokers, marketing men, PR consultants, journalists and the hospitality industry that therefore have a vested interest in maintaining the illusion that they are "special".

[Lootman]

Comparing HFs with an S&500 tracker is comparing apples with oranges.

Not at all. In the same way that they are both fruits, trackers and hedge funds both invest in capital markets.

You are missing workshy's point. You should have quoted his entire paragraph:

As for the comparison between the S&P and hedge funds, this misses the point entirely. I have a considerable number of alternative investments in my portfolio, including hedge funds. I want a portfolio that acts like a university endowment; absolute return of CPI+3-4%, very low vol/drawdown, high Sharpe and low correlation with major asset classes. The whole point is for them to generate a consistent absolute return (high single digit) with minimal drawdowns and no correlation with the S&P500. Comparing HFs with an S&500 tracker is comparing apples with oranges.

A comparison with the S&P 500 is only valid if that index is your benchmark. It clearly is not workshy's benchmark. Rather he is looking to achieve perhaps more modest positive returns regardless of what US shares do. I'd assume that he would, for instance, accept 80% of the return on US shares in return for taking only 60% of the risk.

Now, whether hedge funds achieve such goals is a legitimate line of inquiry. But at least the principle of investing in them is to improve your risk/return profile over a rather mindless 100% exposure to shares.

Each hedge fund is unique so considering them as an asset class is missing the point. It's more a matter of finding one with a similar investing ethos and objective as you have yourself. If I could get into Jim Simon's Renaissance Technologies hedge fund I would, but they routinely turn away investors with only a mere few million

[colin]

Workshy wrote..The clear problem here is that as the company issues more and more debt, it's weighting in the index will increase. This may well be correlated with increased default probabilities.

This argument smells to me like something put about by a fund manager in order to bamboozle the unthinking long enough to sell them some funds.
If company A has borrowed more money than companies BCD then that is only because investors have chosen to lend them more money, so the question then becomes why? If the market is being efficient then that is because they offer a fair return based on a risk and reward basis, if the market is not being efficient then that is due to the behavior of active managers, not passive index funds.

tjh290633 wrote..You have some strange ideas.

It's only simple logic though I quite see why you find it challenging, all I can suggest is that you persevere and with some intellectual effort "the penny may drop" Good luck.