reducing it solves a political and market structure problem, yes, but also creates a social problem in that many people have come to rely upon access to diversification plus a valuation-independent expectation of reliable outsize returns over a 5+ year horizon. 1/
none of which is distinct from the political support of market returns, which exists precisely because so many politically sympathetic people have come to rely upon access “the market” as a diversified aggregate. /fin
Insurance is a broad category, some of it is great, a lot of what is private ought to be public social insurance. 1/
But yes, it’s diversification that is the fount of more urgent problems than the active/passive distinction per se. Today’s indexers having fees skimmed in heavily diversified active funds wouldn’t much address any problems. /fin
i am always wrong about everything! i’m annoyingly persistent, but do disagree!
the corporate governance issue (a more speculative case) doesn’t depend on the skill or attention of the supervisor, but their incentives. 1/
a very skilled and attentive diversified investor might prefer collusion, or even let some firms fail because the enhancement of market power in the remaining firms would more than make up the loss. 2/
shareholder skill and attention under these circumstances is a negative. shareholder skill and attention is socially valuable when shareholders are undiversified, and so want their horses to compete better than the other guy’s. /fin
yes. it is idiotic to make a reasonable retirement contingent upon people participating in capital allocation markets without information. that’s the root of the problem. if you don’t address it, than social stability requires number-go-up, regardless of whether that’s allocatively efficient.
one of many very powerful challenges we face. there’s tremendous parallel between indexing and housing. in both cases we’ve built a political economy that supports number-go-up even though from a broader perspective it’s suicidal.
i think we want to distinguish aggregate market value from individual share relative value. i agree that flow has a strong effect on aggregate market value (i’m not endorsing the number you quote though). 1/
i also think for individual issues, flow effects are asymmetrical with respect to relative value, that is colorably undervalued shares react more to flow than shares widely perceived to be fully priced or expensive. /fin
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