Index Investing

(05-01-2017, 10:27 PM)TTTI Wrote: Ah I see. I misunderstood what you meant.
I thought that you mean that as more and more people go passive and buy ETFs, liquidity would be a problem, that is, it becomes illiquid and hence it is inefficient.
Hence my reply that ETFs won't be illiquid cos they can keep issuing units and there won't be "insufficient" units.

What you really mean, is that the prices will keep rising as there is increasing demand for ETFs. Which is similar to what I said.
And in the meantime, there'd be larger misallocation in the non indexed companies.
This is of course, hypothetical. In reality, there'd always be ppl hunting in the active management space.
We all like to think we are all superior. Something that is impossible, by definition.

hi TTTI,
thanks for clarifying. I do notice serious fundamentals investors like you (or Boon on VB for example) have a good attention to detail, something i can well learn in my personal finance journey.

The 1 thing i would like to clarify is that you seem to imply markets can only become more and more efficient with more money? or we can safely assume so? --> I tend to disagree because i think the correlation is non-linear (some sort of "n" shape curve if we plot a efficient market vs liquidity graph) - so the LHS of the curve is in the regime where markets become more efficient with more money and active management exploit those small caps in that regime. But with the popularity of passive/ETFs everywhere - and the breakdown of market breadth (the top index institutents account for the majority of returns) - i suspect we are on the RHS of the graph now for large caps.

(06-01-2017, 11:01 AM)weijian Wrote:

(05-01-2017, 10:27 PM)TTTI Wrote: Ah I see. I misunderstood what you meant.
I thought that you mean that as more and more people go passive and buy ETFs, liquidity would be a problem, that is, it becomes illiquid and hence it is inefficient.
Hence my reply that ETFs won't be illiquid cos they can keep issuing units and there won't be "insufficient" units.

What you really mean, is that the prices will keep rising as there is increasing demand for ETFs. Which is similar to what I said.
And in the meantime, there'd be larger misallocation in the non indexed companies.
This is of course, hypothetical. In reality, there'd always be ppl hunting in the active management space.
We all like to think we are all superior. Something that is impossible, by definition.

hi TTTI,
thanks for clarifying. I do notice serious fundamentals investors like you (or Boon on VB for example) have a good attention to detail, something i can well learn in my personal finance journey.

The 1 thing i would like to clarify is that you seem to imply markets can only become more and more efficient with more money? or we can safely assume so? --> I tend to disagree because i think the correlation is non-linear (some sort of "n" shape curve if we plot a efficient market vs liquidity graph) - so the LHS of the curve is in the regime where markets become more efficient with more money and active management exploit those small caps in that regime. But with the popularity of passive/ETFs everywhere - and the breakdown of market breadth (the top index institutents account for the majority of returns) - i suspect we are on the RHS of the graph now for large caps.

Hi Weijian
Not more money. More attention/focus/eyeballs
If there are more participants looking at a specific company, naturally all related news would be baked into the share price, or the share price would react more quickly, isn't it?
If you've less attention on a company, there exists a higher likelihood of discrepancy bet price and intrinsic value.
Which is why small caps are allegedly at least, supposed to have more volatility as a proportion of the share price.

Stocks Are No Longer the Most Actively Traded Securities in Stock Markets
Stock exchanges are increasingly getting out of the stock trading business.

As weird as it may seem, individual shares no longer are the most actively traded securities in the market. That distinction goes to exchange-traded funds, which took in a record $400 billion in the past year to become a $3.8 trillion industry.

“What we are seeing is investors are increasingly using ETFs as a replacement for individual stocks,” said Todd Rosenbluth, director of ETF and mutual funds at CFRA, an independent research provider. “That happened in 2016 and it’s going to continue in 2017 and beyond.”

https://www.bloomberg.com/news/articles/...-rules-all

(13-01-2017, 11:07 AM)weijian Wrote: Stocks Are No Longer the Most Actively Traded Securities in Stock Markets
Stock exchanges are increasingly getting out of the stock trading business.

As weird as it may seem, individual shares no longer are the most actively traded securities in the market. That distinction goes to exchange-traded funds, which took in a record $400 billion in the past year to become a $3.8 trillion industry.

“What we are seeing is investors are increasingly using ETFs as a replacement for individual stocks,” said Todd Rosenbluth, director of ETF and mutual funds at CFRA, an independent research provider. “That happened in 2016 and it’s going to continue in 2017 and beyond.”

https://www.bloomberg.com/news/articles/...-rules-all

Wow I did not expect the tides to shift that quickly. I'd think that the consequence of this would be that every one who just piles in into the ETF does so blindly which in turn bids up' the ETF (and consequently the underlying constituents). Since the piling is is 'blind', does it logically follow that the mispricing in the ETF and the constituents themselves will demonstrate symptoms of being 'overpriced' (e.g. elevated P/E ratios, lower dividend yields) ? 

To quote Howard Marks: "There is no asset so good that it cannot become overpriced and thus risky; and few so bad that there's no price at which they're a buy (and safe)."

Some context I dig out and thought would be interesting to share. The ETF fire has burnt for a quite some time now (though i don't have a good picture how long), but i suspect it must have accelerated in the last few years with the indexes (eg. S&P500) outperforming the returns of the hedge fund universe in recent times.

US active/passive flows analysis Morningstar:
Aug report: http://corporate.morningstar.com/US/docu...ug2016.pdf
Exhibit 1 (pg2) shows that US active funds have experienced net monthly outflows in the last 10 years. The rate of outflow accelerated on an absolute basis in the last few years.

Dec Report: http://corporate.morningstar.com/US/docu...ec2016.pdf
The first table on pg3 shows the latest US passive vs active funds total size as of Dec2016 --> Active Funds are 9.6trillion (64.6%) while passive funds are 5.26trillion (35.4%) of the US equity asset market.

Finally, do also note that the indexing is multi-facet and not just restricted to the main indexes only. The passive flows go into all sorts of ETFs (synthetic, non synthetic) that track all kinds of assets (commodities to small cap) in whatever formula (and subsequent benchmark) that the Manager can financially engineered up.

These two articles are a great read to get up to speed on this.

https://www.bloomberg.com/view/articles/...s-industry

http://awealthofcommonsense.com/2017/01/...rmedbroker

(03-01-2017, 11:31 AM)specuvestor Wrote:

(27-12-2016, 03:43 PM)specuvestor Wrote: The excellent classic 30 year old literature to look at is this (disclaimer: I agree with probably 90% of it):
https://www8.gsb.columbia.edu/articles/c...rinvestors

IMHO index investing is as sexy as the nifty fifties or the portfolio insurance or dot coms. As always there are some fundamental truths in it that is extrapolated to stratosphere. I agree with Buffett though that if one doesn't want to spend effort, ETF are good investment alternatives.

Time is the enemy of the mediocre. Over time most ETF of say 3-5 years life you can see that they underperform their respective indices by the fees compounded and unlike managed funds that are worth their salt, of no way to recover.

(30-12-2016, 08:00 PM)thinknotleft Wrote:

(27-12-2016, 10:14 PM)specuvestor Wrote: If investment outperformance over a cycle is less than 0.3% annualised, then index funds should be the next best thing since sliced bread

Hi specuvestor, can u elaborate what you mean?

Anyway, spdr STI etf has annualised 1 yr returns of 5% as at Nov 16, which is not bad.

If u are looking for outperformance, then index investing is not the place to be in. If u are looking for a very lazy way to invest, index investing may be the place for u.

For the past 5 years 2012-2016 (Note FTSE calculation started in 2008), STI returned 27.9% (5% annualised) while SPDR returned 24.4% (4.5% annualised). This 50bps gap will continue to increase next 5 years and it will NEVER recover because that's the cost of the ETF and low tracking error, not outperformance, is the methodology.

For an absolute return fund worth its salt, over an up-down cycle, approximately from 1 Jan 2012 to 21 Jan 2016 (at cycle low), it should be able to beat 8.3% STI return over that 4+ years after fees, especially over and above the 50bps compounded "sliced bread" cost for ETF. That I think is the bottomline and a reference for VBs here.

By 2018 STI ETF will have a 10 year track record of underperforming FTSE STI by >5% and academics can argue again whether it makes sense.

Going forward I think that should be the value of active fund management vs ETF, not comparing just upside, just downside or tracking error, but over a full cycle. Unfortunately I think most long and hedge funds, as well as investors which don't give the right mandate or timeline, don't get this but focus on the latest trends or themes... resulting in the current bad repute.

What Seth Klarman has to say about ETF:

Perhaps the most distinctive point he makes — at least that finance geeks will appreciate — is what he says is the irony that investors now “have gotten excited about market-hugging index funds and exchange traded funds (E.T.F.s) that mimic various market or sector indices.”
He says he sees big trouble ahead in this area — or at least the potential for investors in individual stocks to profit.
“One of the perverse effects of increased indexing and E.T.F. activity is that it will tend to ‘lock in’ today’s relative valuations between securities,” Mr. Klarman wrote.
“When money flows into an index fund or index-related E.T.F., the manager generally buys into the securities in an index in proportion to their current market capitalization (often to the capitalization of only their public float, which interestingly adds a layer of distortion, disfavoring companies with large insider, strategic, or state ownership),” he wrote. “Thus today’s high-multiple companies are likely to also be tomorrow’s, regardless of merit, with less capital in the hands of active managers to potentially correct any mispricings.”
To Mr. Klarman, “stocks outside the indices may be cast adrift, no longer attached to the valuation grid but increasingly off of it.”
“This should give long-term value investors a distinct advantage,” he wrote. “The inherent irony of the efficient market theory is that the more people believe in it and correspondingly shun active management, the more inefficient the market is likely to become.”

https://www.nytimes.com/2017/02/06/busin....html?_r=0

Stock pickers beware: Charlie Munger thinks you're in big trouble

Active investment managers have been taking a beating through most of the eight-year bull market run for stocks, and Berkshire Hathaway's Charlie Munger thinks the pain isn't going to stop anytime soon.

Much has been made over the poor performance of stock pickers. Fewer than 1 in 5 beat the S&P 500 in 2016, driving half a trillion dollars of investors cash into indexes, primarily through passively managed exchange-traded funds.

During a talk Wednesday, Berkshire's vice chair had little comfort to offer.

"The index thing is absolute agony for investment professionals … who have almost no chance of beating it," Munger said. "Most people handle that with denial ... I understand — I don't want to think about my own death, either."

More details in http://www.cnbc.com/2017/02/15/stock-pic...ouble.html

As you read this musty historical artifact, bear in mind that two decades ago, swashbuckling active managers were magazine cover boys and TV stars and could sweep hundreds of millions of dollars of new cash into their funds on the strength of a single spectacularly lucky stock pick. Investors followed mutual-fund performance as fervently as sports fans track a championship race. Most investors had never heard of survivorship bias. And Vanguard’s largest index fund, then called Index Trust 500 Portfolio, was only beginning to become popular, with $40 billion in total assets.

The accepted wisdom was that actively managed funds could make you rich, while index funds were a guarantee of mediocrity. Incredible as that may sound today, it has taken two decades to reverse that view. What I wrote below, in 1997, was almost heretical at the time. I can still remember the dozens of letters — yes, letters, many of them written in pen on legal pad — I received from readers outraged that I didn’t respect their superior skills as fund-pickers. I also can still remember that many of the funds they were proudest at having identified have long since gone out of business.

All of this raises another question: Has indexing become intrinsically dangerous now that it has become almost universally and unquestioningly accepted as an investing strategy? Many active managers are arguing that indexing must, by construction, become invalid once too many people believe in it. We must be in an indexing “bubble,” they argue, because the strategy has become such a mindless consensus.

More at Jason Zweig's blog: http://jasonzweig.com/and-now-for-someth...dex-funds/

Here is an interesting article by Cullen Roche about what he considers to be "The Biggest Risk of Passive Investing"

http://www.pragcap.com/the-biggest-risk-...investing/