Moving Away From Indexing

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IlliniDave
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Re: Moving Away From Indexing

Post by IlliniDave »

Farm_or, yes, I think in the aggregate it is pretty much the same as it would be without index funds. 60% of the market is not in index funds and it has basically the same distribution as index funds because index funds by definition track the overall distribution of equity-invested $. Index funds are closer to thermometers than thermostats, and I think that will be true unless we see the highly unlikely condition that index funds own virtually 100% of the market.

I'm sure there is data out there, but if you ignore people that actively (frequently) trade ETFs, I don't know of any atypical group of investors who are buying index funds and would be non-investors without them.

Yes, I think it is human behavior/emotion that drives the big ups and downs in equity valuations. In the simplest sense index funds are just baskets of stocks, like any other mutual fund/portfolio. When people en masse decide they don't want stocks, they won't pause to consider whether they are indexed or actively managed, they'll just sell.

I don't know what conclusions one can draw from this past February. 10% dips are not uncommon, and weren't prior to index funds. That the correction was only 10% indicates to me that the substantial majority of investors did little or nothing, irrespective of how their investments were managed. Stock pickers aside, I don't think index investors on the whole are that much different from investors who rely on non-index mutual funds or otherwise hire active mangers for their investments. Index funds are the tool of choice for buy/hold strategies, but such strategies are easy to embrace intellectually and difficult to stick to in practice. We'll see when we have the next truly big plummet, but my guess is that people are people and that the behavior of those who choose index funds will largely mirror that of other investors. Some will stand fast, some will bail, and some will wade in deeper hoping for "bargains".

ETA: To prevent misunderstanding, don't get me wrong, stock index funds are fully exposed to systematic market risks, and with high valuations I believe stocks carry a little more risk right now. But I don't think general index funds carry much in the way of peculiar risk that differs from whatever segment the index pertains to. Some of the creatively derived ETFs might be an exception, but I don't pay attention to them and I think they are small in effect when talking about events on the scale of market crashes.

Farm_or
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Re: Moving Away From Indexing

Post by Farm_or »

Those are some good points. Some of it I will have to ponder.

The idea that the recent 10% dip was normal caught my attention. And you are correct. But it garnered a lot of attention because it was abnormal from the new normal. I suppose that you can only differentiate based on how far back you decide to start gathering data. Because what better indicator of the future do we really have than the past? But that doesn't help all that much because the past covers every plausible circumstances if you go back far enough and look close enough...

And that is what has kept me mostly conservative for almost a year now. I've seen too many models that suggest more gain is to be made waiting for the dipper than having that money invested in high valuations. But the indexer factor may be significant enough to influence that idea, or at least modify the response?

If I understand your thermometer analogy, it will be a buffered response? More like a car with shock absorbers instead of the past car riding on springs only? February's correction could have been much greater and more oscillating.

ThisDinosaur
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Re: Moving Away From Indexing

Post by ThisDinosaur »

Augustus wrote:
Thu Mar 15, 2018 9:53 am
I'd also guess that more people are in the stock markets than before, as it's become attractive again.
Is that true though? I think its crucial. On the one hand, I read "facts" that the vast majority of people have less than a couple grand in savings, and on the other hand I read that defined contribution retirement plans are ubiquitous.
Farm_or wrote:
Mon Mar 12, 2018 7:35 am
Because what better indicator of the future do we really have than the past?
I agree, but remember that index funds are a new invention, only a few decades old. But it is hard for me to see how that makes the behavior of the market materially different. Like, how is agnostic cap-weighted index fund buying any different than agnostic South Sea Company share buying?

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Re: Moving Away From Indexing

Post by jacob »

Widespread use of indexing does three things. Indexing currently accounts for ~50% of the market, so these money flows do not exist in a vacuum---when the piggybacker has about the same mass as the pig, its [mass] is no longer negligible. It's important to realize that the market determines the [last trade] price level by the absolute size of the supply and demand money flows. Not the other way around!

This has three effects.

1) It increases correlation between the stocks in the index. This is regardless of whether it's the S&P500 or an ETF representing a subset (e.g. the spiders). When 50 or 500 stocks are all bought and sold AT THE SAME TIME, correlations between the securities in the vehicle increase. This action destroys the diversification-argument. IOW, using an index to diversify company-risk is no longer effective. Indexers have now created a "basket-risk" that's beginning to dominate the "company-risk" that the indexing strategy was trying to avoid. This kinda goes back to the wisdom that risk can never be eliminated, it can only be moved around. TANSTAAFL. This is essentially the "strategy-diversification" issue. With more and more indexers in the market, there are fewer and fewer strategies. More and more herding.

2) While there are many ways to construct indexes, the most widely traded and held indexes and ETFs are all cap-weighed and float-adjusted. (DJIA is an exception). See e.g. https://www.investopedia.com/terms/f/fr ... dology.asp ... this means that when indexers plow money into the market, the money primarily moves to companies with less insider-holdings (not part of the float)(*). This then makes those companies bigger relative to other companies in the index (the value of the float of the company increases). When new money goes into the index again, they become even bigger. This is an exponential effect on the biggest companies. We're talking amazon, apple, and google, here. It would not surprise me that as long as the market keeps rising, these three will keep beating the market because of that tailwind.

(*) Suppose you have two equally large companies and company A has 50% insider ownership (50% float) and company B has 90% insider ownership (10% float). Then when an indexer puts in a buy order for $1000, then $200 will go into company A stock and $800 will be going into company B stock. Please verify the math! Once this allocation strategy begins to have an impact, company B will receive most of the monies that people put in. It will also lose most of the monies if indexers decide to start selling.

3) The increased number of price-insensitive investors means that price-setters have less clout when it comes to moving prices. Most value investors should welcome this since it means less competition. (Often the problem is in establishing one's position BEFORE the rest of the market catches onto the fact.) However, this also implies that monies get misallocated (shite companies get investor-money at the same rate as good companies as long as they're in the index) which is bad for the economy.

ThisDinosaur
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Re: Moving Away From Indexing

Post by ThisDinosaur »

@Jacob
So the question is what to do about it. If all liquid investible assets are in some index, and multi-asset allocation is the most popular strategy, than nearly all price movement will be dominated by indexer buying and selling. This hurts value investors and anyone else in any securities market as much as it hurts the indexers.

This leaves market timing and private equity as available strategies, yes? (I'm putting aside homesteading and skill development as different categories of thing.)

IlliniDave
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Re: Moving Away From Indexing

Post by IlliniDave »

Augustus wrote:
Thu Mar 15, 2018 9:53 am

I'm not so sure about that. I think many investors previously did indeed pick individual stocks. Index investing has been made to sound like a sure thing to many people, so more people are putting money in than they would have without index funds. Due to the weighting factors and rebalancing factors, certain stocks are being chosen over others in a new way that has not been used as widely in the past, so money is going to different places. I'd also guess that more people are in the stock markets than before, as it's become attractive again. Smaller investors seem to go on a cycle of getting heavy into stocks then getting scared and staying out. All those things added up imply to me that stocks held by popular indeces will get hit extra hard when investors eventually do panic. But who knows...
The only place I've seen index funds presented as a "sure thing" is in the construction of a straw man to argue against them. I don't know about the whole world, but among Vanguard index funds the total market fund is the largest and fastest growing, but I wouldn't go seeking refuge from a crash in microcaps and bulletin board stocks. In the US there are essentially no stocks listed on the major exchanges that aren't part of a popular index fund.

Sometimes young inexperienced investors are convinced stocks are a sure thing, but they usually learn fairly quickly. I had the benefit of starting my investment career soon after Black Friday in '87 so I always had in the back of my mind 20% could evaporate in a single day. And I've seen nothing to dissuade me from the belief that the 60% of the money out there that isn't in an index fund will behave the same. People that buy index funds aren't a new species. I'd bet a large majority have, and most of those probably still do, invest to an extent outside of index funds. Just looking at the wealth distribution of the US tells you that wealthy, financially sophisticated investors have to be a big part of the move to index funds--there's just not enough total wealth in the hands of the new college grads chipping in 6% to get their match, and other people who have never invested before, to own 40% of the market.

If a person doesn't like stock index funds there are plenty of other ways to invest. But it will be hard to remain disjoint from all the stocks which show up in mutual funds, index funds included.
Last edited by IlliniDave on Thu Mar 15, 2018 5:55 pm, edited 1 time in total.

IlliniDave
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Re: Moving Away From Indexing

Post by IlliniDave »

Never mind, misread something.

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Re: Moving Away From Indexing

Post by IlliniDave »

jacob wrote:
Thu Mar 15, 2018 11:46 am

(*) Suppose you have two equally large companies and company A has 50% insider ownership (50% float) and company B has 90% insider ownership (10% float). Then when an indexer puts in a buy order for $1000, then $200 will go into company A stock and $800 will be going into company B stock. Please verify the math! Once this allocation strategy begins to have an impact, company B will receive most of the monies that people put in. It will also lose most of the monies if indexers decide to start selling.
That's interesting, I've always thought the opposite: If both companies were worth $1B then A has $500M outstanding and B has $100M outstanding a so for float-adjusted market-weighted $1000 investment 5/6 ($833) would go into A and 1/6 ($167) into B, making the percentage of the total outstanding shares of each that were purchased equal. In a sense it renders the the company that is more insider controlled "smaller" than the one that was more publicly held. If the more internally controlled company had the same $ inflow, it would arguably lead to a distortion of sorts (equal demand for fewer shares) causing B to rise more than A.

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Re: Moving Away From Indexing

Post by jacob »

@iDave - Ah, yes, typo. I switched A and B in my example. That's what I get for editing and pasting things around. Thanks for checking.
jacob wrote:Then when an indexer puts in a buy order for $1000, then $200 will go into company A stock and $800 will be going into company B stock. Please verify the math!


should have been
jacob wrote:Then when an indexer puts in a buy order for $1000, then $200 will go into company B stock and $800 will be going into company A stock. Please verify the math!


Otherwise, what I said holds. Since the companies with more float/less inside-control will comprise a increasingly larger share of the index every time people buy the index. This means that those companies with the largest float get a momentum boost [by construction] in the market (where float matters) relative to the economy (where float doesn't matter). Float-adjusting is done to reflect market behavior, not economic behavior.

To see why float-adjustment, imagine a company with 99.99% insider holding. Since the float is tiny, any liquidity flowing in or out would significantly change the market price because it would be hard to find enough shares on the other [maker] side. Float-adjustment is thus an execution convenience. In sends the money flows towards the securities that in proportion to how much float they have available to absorb investment flows.

On the flipside, and this is the economic complaint, this means the the market no longer serves as equity financing but rather as a savings vehicle. For example, a company with 99.99% insider ownership would probably not see public financing. => It should be privatized (private equity).

IlliniDave
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Re: Moving Away From Indexing

Post by IlliniDave »

jacob wrote:
Thu Mar 15, 2018 7:51 pm
Float-adjustment is thus an execution convenience. In sends the money flows towards the securities that in proportion to how much float they have available to absorb investment flows.
It is, but I believe the convention predates mutual funds taking advantage of it. When you want to provide the general public an overall measure of the stock market they invest in, it makes sense to include only shares the general public can own. That is more/less what SP originally did before the idea of an index fund was ever floated. Then in time it became the benchmark everyone tried to beat and later still certain mutual funds came along and said I want a representative slice of that market (to match the benchmark) and what SP does not only makes sense from a measurement perspective (hense wide acceptance as benchmark) but it is cost effective to implement. So from a traditional index fund the pressure from buying or selling is spread equally in terms of (transaction dollars)/(sum of all dollars worth of shares out there) across all members of the index (what I think you were saying a few posts above). That's why the market becomes nonsense when the ratio of index/non-index holding nears infinity. It is similar if it all got held by "buy and hold" investors, or if it all got bought back by the companies/insiders with no reissues. Can't have any zeros that might wind up in a denominator!

ETFs/closed end funds I'm not sure about. Once the initial purchase is made, buying and selling by investors occurs between one another at a price they set and the underlying company shares stay out of the market. In a way they become like non-float. I don't know if anyone like SP, MCSI, Russell, et. al., who create indices account for ETFs that way in their float calculations.

But forgetting about the hypothetical future for now, in the big picture sense I don't think having a market crash tomorrow or in the near future will look any different than what we've seen to date, nor will people that own index funds do any better or worse than the rest of the market as a group. There has always been "basket" risk (aka systematic risk) that market participants in the aggregate are exposed to. So next time it will be "the same but different", but I think every crash has been "the same but different".

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Re: Moving Away From Indexing

Post by Seppia »

jacob wrote:
Thu Mar 15, 2018 11:46 am
Indexing currently accounts for ~50% of the market,
But what percentage of the trades?
Is it wrong to say that prices are mostly influenced by the amount of money moved?
Ie if you own 50% of stock A and I own 10%, but you never trade while I have a 100% turnover per day, I would expect my behavior to influence prices more than yours.
If the above is true then I think we should look at what indexes represent in terms of % trades.

Now I am sure many indexes are mostly used today as a trading vehicle (SPY is one of the top traded instruments IIRC), so all you said holds true.
For the USA.
In Europe indexing is still almost non-existent, so the effect should be a bit muted over here.

Also worth mentioning: I have no data to back this up, but it seems to me that during drops correlation has always been high.
I started investing in 2006 and remember that during the depths of the financial crisis it did not matter which stock you owned: they all got hammered similarly (I remember to this day buying Axa for 5.8€).

Mixing the two points above (1 what matters most is the volumes of trading not the volume held 2- in the short term downturns correlations tend to be high) my completely uneducated guess is that in case of a drop, the trading of indexes should increase correlation in the short term as “fake buy and holders” drop their holdings en masse.
I’m still confident in the long term though price discovery will do its magic.

All of this said, I am not really an index dogmatist. I currently own 50-50 indexes and individual stocks.
I also have been monitoring their performance since 2016 January 1st, and my individual stocks are beating the indexes by about 3%. Not significant enough to be representative in such a short amount of time.

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Re: Moving Away From Indexing

Post by IlliniDave »

Seppia wrote:
Fri Mar 16, 2018 1:57 am

Also worth mentioning: I have no data to back this up, but it seems to me that during drops correlation has always been high.
I started investing in 2006 and remember that during the depths of the financial crisis it did not matter which stock you owned: they all got hammered similarly (I remember to this day buying Axa for 5.8€).
I think this is pretty well accepted, and referred to, at least informally, as market beta. It works on the upside as well as the downside, though I think correlations tend to be higher during major falls. Many more people decide at some point that, "I want to invest in stocks" than "I want to invest in company XYZ." So most of the time there is a steady inflow of money the bulk of which some sort of professional management deploys. When it is active-style management, yesterday they bought yesterday's good picks raising their price leaving other stocks to be today's best picks. This plays out day after day, week after week, month after month, often year after year. In time the tide will raise nearly all the floating boats. I suppose index-style management does that more directly by just buying a tiny bit of everything every day.

It's basically what jacob said above, the net inflow causes prices to rise and the volume of inflow dictates the sharpness of the rise. The converse can be said for outflows. Now that index-style is a substantial minority it would be interesting to see what concrete evidence there is that market dynamics have forever changed. Undoubtedly there is some. Long ago, before I knew what an index fund was (although ironically I had some money invested in one that was on my 401k plan roster, the infamous Vanguard 500 Index Trust, or whatever it was called back then), I concluded that I was pretty much stuck with beta. Every mutual fund I could invest in as part of the plan held hundreds of stocks strewn all over the market. I could cheat a little small or growthy or dividend-y but none of those circumvented crashes, and were all pretty highly correlated with the market as a whole. In time I began to think of stocks on a marco level (and I still do)--I'm investing some in corporate America, some in the ex-US developed corporate world, some in the emerging corporate world, and some in bonds. Probably something like 6,000-8,000 companies overall (and even then, on the downside, correlation shoots up). I guess you could call it a bet that on balance the corporate world will continue to be profitable over the next 30ish years. In the end you pay your money and take your chances.
Last edited by IlliniDave on Fri Mar 16, 2018 7:16 am, edited 1 time in total.

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Re: Moving Away From Indexing

Post by jacob »

@Seppia - I don't know, but I would guess much more due to algos arbing between ETFs and indexes, particularly the futures (S&P500, DJIA, and Russell3000). Algos are 90%+ of all trades. SPU (the future) drives the SPY (the ETF) which in turn drives individual stocks. What this means is that the driver tends to move first (a few ms before the next). This is too fast for most people (including professionals) to take advantage of(*). It requires heavy investment in fancy technology(**). However, it shows which side of the market is the dog and which is the tail.

(*) The best way to picture this is a bunch of people trying to get a door breaker deal on a sale. If there's no queuing up in advance allowed right in front of the good, it will always go to the fastest runners even if everybody is told about the deal at the same time. So you (most traders) can see, but you (only those with the right hardware) can get it. People who "can see it but not get it" refer to such trades as vapor-trades.

(**) The profit of which drives the development of electronic markets in the same way that porn drives the internet.

During drops correlations will increase because most of the hot (very active) money is invested on the margin. This is a different effect. Margin calls cause traders to sell anything with a profit to raise cash to cover themselves. This is why during a crash, you'll often see the best performing securities take a hit. For example, in 2008/09 which was a credit/liquidity crisis, gold which should have performed spectacularly went down as well.

So as I said above, what matters to the market is the volume traded (hence float adjustment) or the "flow"; but what matters to the economy (equity financing rates) is volume held or the "stock". Focusing on flow is accurate to the first order, but when it's cap-allocated, it induces a Matthew effect which is reflected in the price for reasons that are not related to the economy.

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Seppia
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Re: Moving Away From Indexing

Post by Seppia »

Interesting thoughts thanks Dave and Jacob.
I would add to Dave's post: in the past, there were many, many higher fees "active" funds that were really just closet indexes.
This is why Ritholtz always mentions that what we are experiencing is more of a shift from high to low cost rather than a shift from active to passive.
A ton of people trade indexes daily, they have just became instruments for buying and selling large amounts of stocks at the same time.
In this sense, it is logical that when the sharp movements occur, they will be much more in synch across all stocks.
the shit ones will rise/drop toghether with the great ones.
But still, I would guess the mantra "the stock market in the short term is a voting machine, in the long term it's a weighting machine" will still hold true.
I do think many newfound "passive" investors will be hammered hard.
As hard as they always have been hammered actually, or maybe harder.
They will just be hammered differently.

Still, I believe that those who buy regularly and hold forever large indexes* will get similar results than in the past, and by "similar results" i mean "vastly outperform the average investor".
I have always thought that simply avoiding shooting myself in the balls puts me in the 75% percentile of investors, which is good enough for me.

I'm not that surprised to see, after two years of tracking which is admittedly a very short time, that I have a very similar performance in singe stocks and indexes as mentioned above.

*the amount of bullshit indexes apperaing left and right and their downside potential is a whole other story

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Re: Moving Away From Indexing

Post by IlliniDave »

jacob wrote:
Fri Mar 16, 2018 7:13 am
@Seppia - I don't know, but I would guess much more due to algos arbing between ETFs and indexes, particularly the futures (S&P500, DJIA, and Russell3000). Algos are 90%+ of all trades. SPU (the future) drives the SPY (the ETF) which in turn drives individual stocks. What this means is that the driver tends to move first (a few ms before the next). This is too fast for most people (including professionals) to take advantage of. It requires heavy investment in fancy technology. However, it shows which side of the market is the dog and which is the tail.
That's interesting because it puts traditional mutual funds (including traditional index mutual funds) at the tip of the tail since their value is, by statute, based on day-end NAV, a constraint ETFs (which can trade intra-day at premiums and discounts) don't have. Just curious, do you know offhand what % of algorithmic trades are futures trades? It sounds like they are indeed the driver in the short-term movement, and longer-term movement is in a sense their integral over time.

I guess my question would be if it is speculation on index/ETF futures (i.e., the futures for broad swaths of the market, DOW aside) that are the true driver of stock prices, where does the drive for the little table you can find on nearly every stock market report web page that shows the days "winners and losers" where there's lists of individual issues that will often move an order of magnitude more than the various indices in the same or opposite directions? Futures trading on them are maybe their driver? Then they must in the aggregate be among the drivers to the index futures activity?

Those are real "thinking out loud" questions, not attempts at being argumentative.

It seems like by virtue of owning only old-fashioned mutual funds I am just a poor short-legged puppy trying to keep up with a bunch of greyhounds chasing a rabbit. :)

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Re: Moving Away From Indexing

Post by jacob »

@iDave -

My comment was in terms of how things are arbitraged e.g. long the SPU+short the SPY => beta=0 and trying the make the spread or otherwise bring their prices together. The volume (in $ terms would be the same). Similarly, there would be arbers between the SPY and its constituents. There are mechanisms to ensure this [zero risk]. For example, the SPU is ultimately cash-settled (third friday of the month IIRC) and all ETFs can be redeemed for the individual shares (read all the legalese). So, if you need to put on the spread (SPU-SPY), then the SPU-leg almost always moves first.

Similarly between SPY and its 500 holdings. It's very hard (and expensive) to fill 500 orders (one for each company). This is the problem for index companies to solve. They generally do this very well. (This is where the tracking error comes in and it's usually near zero, but not zero.) Again reading the legalese, some ETFs are allowed to use futures to mimic the index or otherwise only purchase representative constituents. Kinda like maybe a gold ETF doesn't hold metal exclusively but might deal with money flows via the futures market.

The volumes for the futures are public. For everything else, one can not know. There are about 40 exchanges in the US alone. Many of those are dark (you don't see public prices) and trades are executed computationally via an order matching algo.

The drive for the "little table" comes from people buying individual stocks. They still comprise the other half of the market. But if they die out, the little table would be void. Essentially what you have is

total drive = future drive + "sector" ETF drive + stock drive

You could split those apart and get actual numbers with a factor analysis. The published beta is derives from such a factor analysis between the future and the individual stock ... but you can split it further or differently and calculate something like a sector beta, and so on.

I said that the dog almost always moves the tail (in the short run), but if you buy a lot of AMZN or dump a lot of GE, the tail is yanked hard enough to move the dog. Futures traders are also capable of calculating what price index should be based on the combined(*) bid and ask or midprices from the exchanges they can access (usually not all 40ish of them).

When betas go up, the correlations approach 1. If all correlations were 1 on all timescales, it doesn't matter what you buy anymore. They all move exactly the same on all timescales. If people weren't out there arbing the hell out of this, the disconnects (in pricing) would be easier to see. Right now, they only exist on the millisecond scale and when flash crashes occur (arbers pull out of the market... which is why liquidity dries up.. some regulators have proposed making it illegal for them to pull out just when liquidity is needed the most. If this becomes law, expect arbers to increase the spread the demand => higher commissions for retailers).

(*) If you imagine 1 cent spread on all of the 500 (and that's generous.. the spread of high priced stocks will be larger), then there's a $5 spread on the sum (500 x 1 cent) minimum ... but if you look at the spread of the SPY it will definitely be less than 5 bucks. Thus the sum of the parts is not a good signal for the sum of the whole. This is why it's hard for the tail end to guide the dog itself. All the sum tells you is that the index is between 2885.45 and 2893.32 for example. That's not accurate enough to decide whether to trade the future sitting t 2891.73/74 for example. Conversely, when the index moves, you know exactly how much individual stock should be bought and sold based on the percentage in the index... at least to the zeroth order.

Mutual funds and mutual index funds will typically block trade (it's the only reasonable way to acquire 100,000 shares). A managed mutual fund will just trade differently than the index (at least in principle, unless they're a closet indexer.. which many dayjobbers turn into). You'll note that a Vanguard index fund also publishes NAV at the EOD. Whether a fund uses NAV or the block-redemption mechanism like an ETF is just a matter of how you acquire the shares. Keep in mind that a fund that uses NAV will still trade their account in the market during the day (and move stuff on the "little table")... NAV is calculated as the value of the holdings EOD and this price is what the retailers have access to.

Maybe part of the confusion is that people commonly believe that when they buy 100sh of SPY, for example, they specifically own a basket of stocks or a basket of the whole market or whatever. They DO NOT! They own 100sh of SPY. Vanguard buys and sells SPY and individual stocks in a way so that the prices line up. Unless you're a major player (access to block redemption), you can not back the truck up to Vanguard and exchange your SPY for its holdings.

Put it another way, just like cash is not wealth but rather a claim on wealth, SPY is a claim on stocks (as per the prospectus). It requires a functional market for the actual exchange.

TL;DR - all this mostly concerns the detailed plumbing of the market. Most of the time we take it for granted. However, it's good to know if there are leaks in the plumbing or whether we're constructing plumbing that don't match the water and sewerage requirements.

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Seppia
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Re: Moving Away From Indexing

Post by Seppia »

jacob wrote:
Fri Mar 16, 2018 7:13 am
During drops correlations will increase because most of the hot (very active) money is invested on the margin. This is a different effect. Margin calls cause traders to sell anything with a profit to raise cash to cover themselves. This is why during a crash, you'll often see the best performing securities take a hit. For example, in 2008/09 which was a credit/liquidity crisis, gold which should have performed spectacularly went down as well.
thanks for the clarifications in the post quoted.
regarding your following post (the one just above), I'll need to read it again after I let my brain cool down a bit. been working all day on the PC and I'm burned out.
Always great reading you as there is always depth + detail + simplicity in the way you articulate it, the sign of real knowledge of the subject ("if you cannot explain it to your grandmother you don't really understand it")

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Re: Moving Away From Indexing

Post by Mister Imperceptible »

jacob wrote:
Fri Mar 16, 2018 7:13 am
During drops correlations will increase because most of the hot (very active) money is invested on the margin. This is a different effect. Margin calls cause traders to sell anything with a profit to raise cash to cover themselves. This is why during a crash, you'll often see the best performing securities take a hit. For example, in 2008/09 which was a credit/liquidity crisis, gold which should have performed spectacularly went down as well.
As an aside, this is what scares me about implementing the conventional PP. If the main contribution of Long-term bonds is capital appreciation, do I trust myself to sell them at the right time in a downturn in order to capture the alpha? The time to do so in 2008 was exceedingly short- it may even be shorter the next time. What if I am off the grid with some beautiful damsel when that time comes?

This seems to me (with my very rudimentary understanding) the problem with any strategy, whether it be index investing, the PP, Dogs of Dow, etc. As the strategy becomes popular, its advantages are arbitraged away.

IlliniDave
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Re: Moving Away From Indexing

Post by IlliniDave »

Jacob, re SPY you maybe meant State Street instead of Vanguard? Vanguard has some apparently clever and proprietary way of treating/making their ETFs alternate share classes of their regular mutual funds. That has no bearing on what you said above, but they have ways of handling redemptions and other buy/sell activities using that "feature" that spin off fewer CG distributions under normal conditions.

Thanks for all the info. I didn't know that you could go to an ETF provider and demand underlying shares (never bught an ETF so never looked into them much). I guess the key is you can't go to them and ask for money the way you do with an old fashioned mutual fund. I also thought mutual funds tended to "hold" the portfolio because of all the discussions surrounding proxy voting by the big outfits like VG and Blackrock. The more I hear about the actual machinations of the market the more intimidated I am by it.

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Re: Moving Away From Indexing

Post by jacob »

@iDave - You need to be big and approved to be able to redeem. As far as I understand only the issuing ETF-company can create new ETF shares.
Random explanatory link: http://www.understandetfs.org/creation_redemption.html
(I've seen the 50,000sh count elsewhere before, so that's the likely magnitude of the size of this game.)

(When you buy a standard mutual fund, they create new shares at the NAV at the EOD. When you sell, they eliminate them. The mutual fund faces some risk in managing those flows. It needs to have the cash at hand if there's a net outflow. If there's a net inflow, it needs to acquire more securities. You'll often see mutual funds holding some cash to facilitate this. Conversely, the number of outstanding shares in a closed-end fund is fixed. It can only be increased by emission, and only be decreased if the company buys its own shares and cancels them (standard buyback operation). Closed-end funds have no creation/redemption mechanism to facilitate arbitrage. That's why the price between the CEF and its bookvalue often diverge ... and sometimes by over 10% usually on the discount side... because there's no redemption mechanism make the CEF hand over the corresponding value of the portfolio. ETFs is pretty much the best of both worlds. It outsources the inflow/outflow problem to arbers ... and eliminates the problem of the fund not tracking its bookvalue. Downside is that ETFs start acting as trading vehicles themselves ... not sure that was ever intended. Even with the future, you don't have to arrange delivery before expiry, but with ETFs, "expiry" is every EOD.)

The mutual fund does hold a portfolio of shares in securities. However, you don't. What you hold is shares of the fund itself. A mutual fund will vote the shares of the securities it holds w/o asking you---because they're not yours---they belong to the fund.I suppose it's similar to how 500sh in UPS is a claim on the equity in the UPS company---not a claim on a truck owned by the UPS company.

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