Yes. Exactly. A system where ordinary savers have to be reliant on the success of vehicles that make the very rich richer, and so tolerate a politics that rigs things to transfer wealth to the very rich so they can get their small piece of the action, is a pretty bad system.
i mean, sure? if profiting from active investing is harder, we can always spim that as we’ve upped the skills required to earn the same compensation, rather than that we’ve diminished compensation. 1/
but its actives who do the informational work behind capital allocation (to the degree it remains meaningfully done at all by contemporary markets). passives are free-riders. 2/
however you spin it — up the skill game, lower return holding skill constant — you are reducing the incentive to do the useful work. /fin
think of it this way: active investors face two distinct challenges. first, they have to gain an informational edge. next they have to exploit that edge at some scale, in markets literally built for price discovery. 1/
when an active investor buys, she does not celebrate if the price goes up immediately. she wants minimal to no to even negative price movement, so she has continuing opportunity to exploit. 2/
what constrains her ability to profit is not lack of liquidity or access to leverage, but the speed with which price usually converges to relative value. 3/
that, once she has found her information, is the main threat to her profit. and that precisely is what index flows exacerbate and render more hazardous. /fin
once we have a world where no one is compelled to participate in capital markets, people without information to contribute should not do especially well if they choose to add noise. 1/
they shouldn’t be “crushed” — we should regulate securities so they’re not frauds and so on average they’re reasonably priced. 2/
but this kind of punter should underperform, to the profit of better informed participants. unless they enjoy the gambling aspect, should come to realize they’d prefer more reliable, low information savings vehicles. /fin
yes.
i think you’re overstating the effect of flow on prices. there’s an asymmetry. flow has a stronger effect when a stock is undervalued than when it is fairly or overvalued (relative to peers, in absolute terms they’re all overvalued). 1/
when a stock is (relatively) overvalued, flow induces counterflow with little price change. when a stock might be undervalued, you have to pay up more to compel sellers. 2/
this is why exploiting information is hard. once the market sniffs any interest, you’re not likely to stay so uniquely informed for long. you want to buy silently, have as little move per flow you provide as possible. but if you screw up a little, here come the passive flows. 3/
and your flow quickly stops having a lot of upside. /fin
loanable funds is not a thing. modern banking systems are not liquidity constrained.
as i keep trying to emphasize, i don’t begrudge individuals using index funds. as you say, individuals have been effectively forced to participate in games they ought not, and index funds are the life raft on offer. all of that scenario i object to though.
i certainly object to making a decent retirement contingent on capital allocation institutions most people ought not need to participate in. for people who choose to participate, my objection is to private diversification more than delegation.
glad you find it worth your time! and as i keep trying to emphasize, this is a policy view, not a personal judgement. i don’t begrudge individuals doing what they can. 1/
i think the idea that index funds enable any kind of collective ownership to be horrid propaganda. there’s no collective ownership! they are privately owned, and the very rich own much larger pieces of them! 2/
it’s a way of confusing with social democracy participation in an institution designed to align the perceived interests of small savers with the policy interests of the very wealthy. 3/
it’s like how tech companies are always saying they’ve “democratized” something whenever they’ve made something broadly accessible under infantilizing terms they control. that isn’t what democracy means! /fin
no. it’s true that actives get some mechanical echo from index flows. but since that’s unrelated to the quality of their decision-making, it’s noise. 1/
where actives do have information to contribute, this “leverage” means they have less opportunity to exploit. 2/
so it’s quite different from private leverage, which might fund trades by which they’d try to accumulate positions with as little price effect as possible. this “leverage” erases the opportunities it funds. 3/
sure, (relative) price discovery happens, the stock finds its (relative) level, faster than it otherwise might. 4/
but that is not to the advantage of the informed investor. /fin
in other words, we politically lock in a socially destructive racket that makes the rich much richer by arranging things so that ordinary people can’t keep their heads above water unless the rich earn much much more. yes, exactly. we need to undo all of that.
i guess you’ll have to unpack what you mean by free leverage? index flows might, as a second order effect, make it easier for firms to borrow, as they appear more solvent than they otherwise might. firms can take advantage of high valuations via obfuscated issuance, eg options compensation, mergers.
but i think you mean something else, in which case you’ll have to explain it for me. /fin
sure. but first there’s the choice between spending and saving. to a first approximation, what we collectively save goes nowhere. buying a stock or an index doesn’t cause buying factories or anything like that. 1/
whether a CD or an index fund, you’re just deferring consumption. the index fund overpays and undermines what might once have been institutions of meaningful capital allocation. the CD does neither (as long as we don’t set risk-free rates too high). /fin
there is always the risk that policy stabilization breaks — that incompetence or political constraint “nukes” the stock market. i’m not sure that’s a risk we want to compensate. 1/
index investing reduces compensation to active investors because the whole sector is a copycat. 2/
a small price increase in Stock A causes indexes to be under invested, causes them to buy more, accelerating the price shift, reducing the opportunity for the investors who brought information to market to exploit it. /fin
they don’t go anywhere. buying those vehicles rather than spending is disinflationary, leaving more economic headroom for public spending, or if we prefer sector activity, lower rates, and more industrial policy by subsidy.
the answer would be to impose limits to the complexity and scale of investment funds, and to portfolio diversification. if you want safety, buy savings bonds. if you want returns, invest wisely or bear losses. 1/
it will always be the case, for any form of fund with free entry, eventually funds of that form will not outperform the market after fees. as @tylercowen.bsky.social might say, solve for the equilibrium. /fin
the only meaningful sense in which index fund investors “provide capital” is bearing risk. liquidity is not a scarce resource under elastic fiat currency. 1/
you can argue that index investors are compensating for bearing undiversifiable macro risk, and that’s a contribution. it’s the best case you can make for the practice from a social, rather than private, perspective! 2/
except upspiraling valuations and obvious policy stabilization undo that case. if policy (to stabilize employment, they of course will say) targets continuing appreciation and ensures downswings are short, then funds holders aren’t making that contribution. 3/
and when we made indexing a recommended best practice, when we advised sympathetic ordinary professionals to rely upon a practice that also made less sympathetic, less ordinary wealthy people even richer, we created a political coalition that would predictably work to stabilize an upward path. 4/
leaving indexers making the opposite of any contribution. stabilization of capital markets undermines their allocative purpose, income to shareholders has to be offset by disinflationary policy elsewhere. 5/
nonshareholders pay both the expanding profit margins, and, less directly, for the spiraling higher multiples. /fin
there’s lots you can do be said for social arrangements under which baseline ordinary living doesn’t require personal savings. nevertheless, even if, people do want to arrange the timing of their consumption in ways that deviate from their timing of income. 1/
it might well be that “real” credit-risk-free interest rates should be zero or negative much of the time. sometimes, because of a big social project (think war bonds, but for something good), we may wish to pay up a bit for people willing to defer consumption. 2/
but “paying up a bit” would look nothing like the returns index funds “investors” have enjoyed. /fin
they pay a lot less, they don’t pretend to be “natural”, “market”, returns, they don’t interfere with institutions whose role ought to be actual capital allocation. 1/
arguably they’ve paid too much, but we as a polity can make what choices we want about what compensation should be (probably negative during recessions!) for merely deferring consumption. /fin