Author Topic: As more people index in index funds  (Read 21433 times)

hatersgonnahate

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As more people index in index funds
« on: April 25, 2014, 12:21:11 PM »
It seems like it is just money thrown to the stars, becoming a force in of itself in the market with no real risk/goal/meaning. Who is going to drive the market as more people invest in indices? If you are investing in something, you are predicting future gains, and this could be backed up by your own analysis, knowledge, supposition, etc. It just seems like index investing is "putting money out there" while letting other people take the risks. But if more and more people invest in index funds, what would happen to the market? The winners would find themselves overvalued and once you break into the index you would get a boost of money? It would be easy for any active investor to understand the nature of index funds and account for the flood of money in their stock analysis that is predetermined by a simple formula, especially if it becomes a large market force in of itself.

matchewed

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Re: As more people index in index funds
« Reply #1 on: April 25, 2014, 12:28:08 PM »
http://forum.mrmoneymustache.com/investor-alley/stock-value-with-a-negative-eps/msg273124/#msg273124

Grant has put it best. But in short no as more people use index funds the market does not disappear.

To address the rest of what you are saying - what do you mean the winners find themselves overvalued? And how does indexing make advantages for active investors, what are they going to understand? And what do you mean by a market force, it's a passive index that reflects the actions of a market after the actions have been made, how will that change the market?

hatersgonnahate

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Re: As more people index in index funds
« Reply #2 on: April 25, 2014, 12:51:49 PM »
OK so an index represents the top valued companies in an index. Say you have an index of the top five energy companies. Your total assets are 10 in this market, the actively managed guys also have 10, and others have 10.

Every now and then, a company breaks out of the five or beaks into the five. Your fund automatically buys and sells these companies when they do.

But the actively managed fund people don't like that and they know exactly when your fund is going to buy and when it is going to sell.

The actively managed guys know what is going on in the market and short the stocks when they are about to go down and they speculate based on the index.

hatersgonnahate

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Re: As more people index in index funds
« Reply #3 on: April 25, 2014, 12:57:06 PM »
Just an idea--why not invest in both the actively managed funds and the index within a particular sector that you know is going to grow in the future? Would this be a better strategy to "corner the market"?

hatersgonnahate

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Re: As more people index in index funds
« Reply #4 on: April 25, 2014, 12:59:52 PM »
I am a newbie to investing, I admit it.

matchewed

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Re: As more people index in index funds
« Reply #5 on: April 25, 2014, 01:10:26 PM »
OK so an index represents the top valued companies in an index. Say you have an index of the top five energy companies. Your total assets are 10 in this market, the actively managed guys also have 10, and others have 10.

Every now and then, a company breaks out of the five or beaks into the five. Your fund automatically buys and sells these companies when they do.

But the actively managed fund people don't like that and they know exactly when your fund is going to buy and when it is going to sell.

The actively managed guys know what is going on in the market and short the stocks when they are about to go down and they speculate based on the index.

No an index represents the index, whatever criteria that may be. It's doubtful someone would make an index of just 10 companies but it's possible. An index can be all of a sector such as energy, or it could be the entire market. Much like the thread here an index can be nearly anything.

How do the active managed people know when something is going to move in or out of an index. You seem to assume that active management has some sort of insider knowledge that is not already publicly available. There is little evidence that that is true. Most of the evidence points to the fact that most active managers do not outperform the market regularly and that very few do. Some certainly do, but by no means is it a large percentage. So no they don't know what is going on in the market. They're guessing based on their own metrics, criteria, and crystal ball reading as much as anyone is.

Just an idea--why not invest in both the actively managed funds and the index within a particular sector that you know is going to grow in the future? Would this be a better strategy to "corner the market"?

Probably not as "cornering the market" is a meaningless phrase.

I am a newbie to investing, I admit it.

http://jlcollinsnh.com/stock-series/

For the basics at least. Or just read the Four Pillars of Investing if you want more in depth investing knowledge.

hodedofome

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Re: As more people index in index funds
« Reply #6 on: April 25, 2014, 02:48:21 PM »
It is true that there are active investors out there that know the strategy of a certain index and front run it before the rebalance date. This is not something you'll hear index providers talk about though... :)

It's hard to say what the effects will be on the market if more and more people index. There are so many different strategies out there and so much money running in different directions, that it would be hard to imagine all the money chasing one thing. Some investors are diversified in many asset classes, some put all their money into 1 index fund. The stock and bond markets are pretty dang large so it's hard to say if they will suffer from the trader effect.

matchewed

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Re: As more people index in index funds
« Reply #7 on: April 25, 2014, 03:04:44 PM »
It is true that there are active investors out there that know the strategy of a certain index and front run it before the rebalance date. This is not something you'll hear index providers talk about though... :)

It's hard to say what the effects will be on the market if more and more people index. There are so many different strategies out there and so much money running in different directions, that it would be hard to imagine all the money chasing one thing. Some investors are diversified in many asset classes, some put all their money into 1 index fund. The stock and bond markets are pretty dang large so it's hard to say if they will suffer from the trader effect.

What do you mean front running a strategy of an index? An index has a certain criteria. Things either meet the criteria and are in the index or don't and are not in it. How does someone front run that? Unless you're talking something beyond a traditional index fund.

hodedofome

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Re: As more people index in index funds
« Reply #8 on: April 25, 2014, 03:15:10 PM »
Take the NASDAQ 100 for example. Stocks are dropped and added to that index all the time. When a stock is announced it will be added, traders can 'bid up' the stock, knowing that some very large orders will be coming in on a certain date, and then sell it to the funds that are tracking the index. This isn't something you or I could do easily, as a lot of this is done by HFT algorithms and by the time you hear about it, the HFT guys have already taken advantage of it. But it happens all the time.

Another example could be an equal weight index that rebalances annually. If you knew when they were going to be rebalancing, you could sell the stocks that have been up, buy the stocks that have been down, and front run the indexers that will be doing the same thing in a few days.

clifp

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Re: As more people index in index funds
« Reply #9 on: April 25, 2014, 03:40:52 PM »
Take the NASDAQ 100 for example. Stocks are dropped and added to that index all the time. When a stock is announced it will be added, traders can 'bid up' the stock, knowing that some very large orders will be coming in on a certain date, and then sell it to the funds that are tracking the index. This isn't something you or I could do easily, as a lot of this is done by HFT algorithms and by the time you hear about it, the HFT guys have already taken advantage of it. But it happens all the time.

Another example could be an equal weight index that rebalances annually. If you knew when they were going to be rebalancing, you could sell the stocks that have been up, buy the stocks that have been down, and front run the indexers that will be doing the same thing in a few days.

I think Micheal Lewis book Flash Boys, makes the case that index funds are front run all the time. Imagine IBM's 401K contributions are sent to Vanguard the 2nd and 4th Wed of each month, and CALPERS redemption's (to pay pension) are issues on the 28 th of each month. Its almost certain that the high frequency traders have figured these patterns out, and are front running both for Vanguards S&P 500 fund.   Increase the cost of the shares for IBM employees by a penny or so and decrease the sales price for Calpers

matchewed

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Re: As more people index in index funds
« Reply #10 on: April 25, 2014, 04:22:03 PM »
Take the NASDAQ 100 for example. Stocks are dropped and added to that index all the time. When a stock is announced it will be added, traders can 'bid up' the stock, knowing that some very large orders will be coming in on a certain date, and then sell it to the funds that are tracking the index. This isn't something you or I could do easily, as a lot of this is done by HFT algorithms and by the time you hear about it, the HFT guys have already taken advantage of it. But it happens all the time.

Another example could be an equal weight index that rebalances annually. If you knew when they were going to be rebalancing, you could sell the stocks that have been up, buy the stocks that have been down, and front run the indexers that will be doing the same thing in a few days.

Do you have concrete examples, such as an equal weight index that waits to rebalance annually? It just sounds hard to "front run" an index as an index just tracks whatever happened to its index for that day regardless of if it is HFT or some other investor deciding to buy or sell his shares. Basically isn't any action that happens in the market happening and then the index tracks whatever is happening. How exactly do you "take advantage" of essentially a measuring stick?

clifp

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Re: As more people index in index funds
« Reply #11 on: April 25, 2014, 04:44:23 PM »
Take the NASDAQ 100 for example. Stocks are dropped and added to that index all the time. When a stock is announced it will be added, traders can 'bid up' the stock, knowing that some very large orders will be coming in on a certain date, and then sell it to the funds that are tracking the index. This isn't something you or I could do easily, as a lot of this is done by HFT algorithms and by the time you hear about it, the HFT guys have already taken advantage of it. But it happens all the time.

Another example could be an equal weight index that rebalances annually. If you knew when they were going to be rebalancing, you could sell the stocks that have been up, buy the stocks that have been down, and front run the indexers that will be doing the same thing in a few days.

Do you have concrete examples, such as an equal weight index that waits to rebalance annually? It just sounds hard to "front run" an index as an index just tracks whatever happened to its index for that day regardless of if it is HFT or some other investor deciding to buy or sell his shares. Basically isn't any action that happens in the market happening and then the index tracks whatever is happening. How exactly do you "take advantage" of essentially a measuring stick?

Typically 2 or 3 stocks are added to the S&P 500 each year (actually 501 stocks today cause both class of Google shares are in the S&P 500).  The ones disappearing are typically due to a merger although sometimes bad financial/bankruptcy like GM a few years ago.  Lets say they are two new stocks ABC and DEF.  At the time of the announcement by Standard and Poor, ABC is selling for $30.00/share and DEF is $50.00 a share.  As far as the index is concerned ABC is $30.00 and DEF $50.00, but because of front running and assorted other tricks no Vanguard, Fidelity, or Schwab index fund is actually going to own the shares at 30.00 or $50.00 instead the average price might be $30.42 and $50.95

Now the index fund may have a low expense ratio say .05% but from the investors prospect the additional $.42 and $.95 they pay for the 2 shares is an additional expense. Along with the month to month cost with losing a penny or so by being front runned.

the fixer

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Re: As more people index in index funds
« Reply #12 on: April 25, 2014, 06:08:54 PM »
A good index fund can largely mitigate this problem. VTSAX is based on a much larger index of 5000 stocks. It samples the index so it's not public knowledge which companies in the index of 5000 stocks the fund trades in, and even if people figure it out there's nothing stopping the fund from switching over to sampling with different stocks for its next round of buys (in fact it would completely follow, as the original sampled stocks are no longer as reflective of the index as a whole if they've been bid up).

For sell orders, who's to say the fund itself doesn't increase its cash reserves a bit early in anticipation of a massive pension sale each month? It could also do the opposite and buy shares early if it has a good estimate of when new inflows are coming. There are a lot of very smart, well-paid people on both sides fighting over pennies on the dollar in this industry. I don't think it's possible for us as laypeople to calculate the damage done to our portfolios as a result, all we can do is determine a worst-case estimate of how bad it is.

clifp

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Re: As more people index in index funds
« Reply #13 on: April 26, 2014, 06:02:28 AM »
A good index fund can largely mitigate this problem. VTSAX is based on a much larger index of 5000 stocks. It samples the index so it's not public knowledge which companies in the index of 5000 stocks the fund trades in, and even if people figure it out there's nothing stopping the fund from switching over to sampling with different stocks for its next round of buys (in fact it would completely follow, as the original sampled stocks are no longer as reflective of the index as a whole if they've been bid up).

For sell orders, who's to say the fund itself doesn't increase its cash reserves a bit early in anticipation of a massive pension sale each month? It could also do the opposite and buy shares early if it has a good estimate of when new inflows are coming. There are a lot of very smart, well-paid people on both sides fighting over pennies on the dollar in this industry. I don't think it's possible for us as laypeople to calculate the damage done to our portfolios as a result, all we can do is determine a worst-case estimate of how bad it is.

I mostly agree it is difficult task. However, something to consider. Michael Lewis and other (including Charles Schwab and the Schwab's CEO) have all been saying the high frequency have are making billions with most common estimate being $10-20/billion per year. If you figure that market capitalization of the US stock market is roughly $20 trillion a year than $10 billion is the equivalent of .05%, which doesn't seem like much until you consider that expense ratio of a Vanguard, Schwab, or Fidelity Index fund or ETF are also .05% so the traders are basically doubling the cost of owning an index fund.

hodedofome

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Re: As more people index in index funds
« Reply #14 on: April 27, 2014, 06:23:39 AM »
Take the NASDAQ 100 for example. Stocks are dropped and added to that index all the time. When a stock is announced it will be added, traders can 'bid up' the stock, knowing that some very large orders will be coming in on a certain date, and then sell it to the funds that are tracking the index. This isn't something you or I could do easily, as a lot of this is done by HFT algorithms and by the time you hear about it, the HFT guys have already taken advantage of it. But it happens all the time.

Another example could be an equal weight index that rebalances annually. If you knew when they were going to be rebalancing, you could sell the stocks that have been up, buy the stocks that have been down, and front run the indexers that will be doing the same thing in a few days.

Do you have concrete examples, such as an equal weight index that waits to rebalance annually? It just sounds hard to "front run" an index as an index just tracks whatever happened to its index for that day regardless of if it is HFT or some other investor deciding to buy or sell his shares. Basically isn't any action that happens in the market happening and then the index tracks whatever is happening. How exactly do you "take advantage" of essentially a measuring stick?

A quick Google search of front running etf rebalance date will give you plenty of reading material. It is well known in the trading world.

matchewed

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Re: As more people index in index funds
« Reply #15 on: April 27, 2014, 08:02:17 AM »
So we're no longer talking about an index fund but an ETF then?

If so we're just moving the goal posts.

the fixer

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Re: As more people index in index funds
« Reply #16 on: April 27, 2014, 02:59:49 PM »
If you figure that market capitalization of the US stock market is roughly $20 trillion a year than $10 billion is the equivalent of .05%, which doesn't seem like much until you consider that expense ratio of a Vanguard, Schwab, or Fidelity Index fund or ETF are also .05% so the traders are basically doubling the cost of owning an index fund.
That would be an average across all HFT activity, only a portion of which would be directed at index funds (the rest would  be taking advantage of other large institutional investors). Of the portion affecting index funds, most of that is going to be affecting the funds backing the most popular indices: mainly the S&P500. VTSAX is a gigantic fund and would be a lucrative target for HFT, but I doubt it gets hit with an average or higher share of the HFT hit in context of the other fish on the radar.

So let's say it's .03%, or $30 per $100k invested. If that's the case, why is it worth even talking about?

hodedofome

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Re: As more people index in index funds
« Reply #17 on: April 27, 2014, 03:57:13 PM »
So we're no longer talking about an index fund but an ETF then?

If so we're just moving the goal posts.

Index fund/ETF/Mutual fund, whatever you want to call it, doesn't matter. If you really care, there's plenty of research out there to find with basic google searches. I'm not going to spend a bunch of time doing everyone's work for them.

matchewed

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Re: As more people index in index funds
« Reply #18 on: April 27, 2014, 04:56:34 PM »
So we're no longer talking about an index fund but an ETF then?

If so we're just moving the goal posts.

Index fund/ETF/Mutual fund, whatever you want to call it, doesn't matter. If you really care, there's plenty of research out there to find with basic google searches. I'm not going to spend a bunch of time doing everyone's work for them.

Ah that strategy. Look no offense but if you're going to make a claim and then take the lazy way out when someone questions it maybe you shouldn't make the claim. It stifles the conversation. Also the topic being discussed was about what happens if everyone moves to index investing.

You've made the claim that active investors are "front running" passive indices which are just a reflection of whatever happened in the market. When asked for proof you cop out with a "just google it" and then try to make me out to be the lazy one? Ha.

Unsupported claims are just hot air and smoke. I think you're blowin' plenty of both at this point.


clifp

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Re: As more people index in index funds
« Reply #19 on: April 27, 2014, 07:44:54 PM »
If you figure that market capitalization of the US stock market is roughly $20 trillion a year than $10 billion is the equivalent of .05%, which doesn't seem like much until you consider that expense ratio of a Vanguard, Schwab, or Fidelity Index fund or ETF are also .05% so the traders are basically doubling the cost of owning an index fund.
That would be an average across all HFT activity, only a portion of which would be directed at index funds (the rest would  be taking advantage of other large institutional investors). Of the portion affecting index funds, most of that is going to be affecting the funds backing the most popular indices: mainly the S&P500. VTSAX is a gigantic fund and would be a lucrative target for HFT, but I doubt it gets hit with an average or higher share of the HFT hit in context of the other fish on the radar.

So let's say it's .03%, or $30 per $100k invested. If that's the case, why is it worth even talking about?

The $10-20 billion cost is spread out across all market participant. I see no reason to think that  Vanguard wouldn't be hit at least is much as average so I'll stick with the .05% figure
Expenses matter and its shame to give the profits to HF traders as opposed to the Vanguards, Schwab, and Fidelity that have worked hard to lower expense for average investors.

The difference between $100,000 earning the stock market average of 9% over 40 years, and 100,000 earning 9.05% over 40 years is >$58,000 still want to argue its nothing?

DaKini

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Re: As more people index in index funds
« Reply #20 on: April 28, 2014, 03:35:48 AM »
But doesn't front running also alter my already established positions in a fund?
And why is that a problem? Should this not flat out over a longer period of time?

grantmeaname

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Re: As more people index in index funds
« Reply #21 on: April 28, 2014, 05:07:07 AM »
The $10-20 billion cost is spread out across all market participant. I see no reason to think that  Vanguard wouldn't be hit at least is much as average so I'll stick with the .05% figure
You still haven't explained how an index like VTSAX is possible to front-run. There's no announced list of trades, just a portfolio that is as close to statistically equivalent to the market as possible without holding more than 20% of the securities or so.

warfreak2

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Re: As more people index in index funds
« Reply #22 on: April 28, 2014, 07:36:05 AM »
So we're no longer talking about an index fund but an ETF then?

If so we're just moving the goal posts.
I think the point was that if it makes a difference to you, you could change "ETF" to "index fund" in your google search, and you would find the same discussions. ETFs and index funds are not seperate categories; ETFs are just wrappers that enable investors to more conveniently buy and sell stakes in, for example, index funds. Vanguard index funds are available directly through Vanguard, and also as ETFs - either way your money is invested in the same index fund, according to the same rules defined by the index.

Quote
You still haven't explained how an index like VTSAX is possible to front-run. There's no announced list of trades, just a portfolio that is as close to statistically equivalent to the market as possible without holding more than 20% of the securities or so.
Actually, he did explain it earlier in the thread, for two examples - the NASDAQ 100 and an equal weight index. He also suggested where to find more information on the topic, but if you wanted information rather than an argument, I guess you'd have looked.

The trades may not be announced, but they can be predictable, depending on the index. For example, S&P 500 or Russell 1000 index funds each buy and sell according to a list of rules which define the index itself, and those rules are public knowledge. According to the fixer, VTSAX and many other funds have defenses against frontrunning, in the sense that the index they track does not define exactly what stocks they should hold in what proportions, but clearly this depends on the index, and the fact that they defend against it at all should be a clue that there is something to defend against.

grantmeaname

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Re: As more people index in index funds
« Reply #23 on: April 28, 2014, 09:19:36 AM »
I said "an index like VTSAX". Not "any index you want to explain", but "an index like VTSAX". I read the thread, and he has not explained how most indexes could be front-run, just two indices that are atypical of index funds on the whole. I am arguing that for VTSAX and other funds like it, that logic doesn't apply.

warfreak2

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Re: As more people index in index funds
« Reply #24 on: April 28, 2014, 09:55:07 AM »
I said "an index like VTSAX". Not "any index you want to explain", but "an index like VTSAX". I read the thread, and he has not explained how most indexes could be front-run, just two indices that are atypical of index funds on the whole. I am arguing that for VTSAX and other funds like it, that logic doesn't apply.
Whatever the index is, the point is that a fund which tracks that index must make trades when the composition of the index changes. You appear to be arguing that it's atypical for an index to change its composition at all, but this is wrong, even for total stock market indices.

hodedofome

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Re: As more people index in index funds
« Reply #25 on: April 28, 2014, 10:03:10 AM »
So we're no longer talking about an index fund but an ETF then?

If so we're just moving the goal posts.

Index fund/ETF/Mutual fund, whatever you want to call it, doesn't matter. If you really care, there's plenty of research out there to find with basic google searches. I'm not going to spend a bunch of time doing everyone's work for them.

Ah that strategy. Look no offense but if you're going to make a claim and then take the lazy way out when someone questions it maybe you shouldn't make the claim. It stifles the conversation. Also the topic being discussed was about what happens if everyone moves to index investing.

You've made the claim that active investors are "front running" passive indices which are just a reflection of whatever happened in the market. When asked for proof you cop out with a "just google it" and then try to make me out to be the lazy one? Ha.

Unsupported claims are just hot air and smoke. I think you're blowin' plenty of both at this point.

[Mod Edit: Personal attack removed.] There's no reason for me to copy and paste easy to find research on a message board. I have much better things to do with my time. I told you where to find it. This was EASY to find, and there's plenty of additional research that is EASY to find on the topic http://seekingalpha.com/article/232654-indexings-hidden-costs

[Mod Edit: Rude comment removed.  Please read the site rules, especially rule #1: Don't be a jerk.]

You have a belief about how markets work. Somebody tells you that your belief may be wrong and then tells you where to find the answer. Instead of doing your own research and learning if your beliefs might actually be wrong, you just tell the person giving you information that if they don't provide proof you won't believe it. It seems as if you're just trying to win an argument, instead of getting to the truth. I didn't become a profitable trader by telling people I disagreed with that they were wrong. I became a profitable trader by taking the information that contradicted my beliefs, and then doing the necessary research to determine if my beliefs were right or they needed to be changed. Staying open minded and research/truth focused instead of always trying to be right, is how we grow and learn.
« Last Edit: April 29, 2014, 07:55:03 AM by arebelspy »

matchewed

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Re: As more people index in index funds
« Reply #26 on: April 28, 2014, 11:10:40 AM »
So we're no longer talking about an index fund but an ETF then?

If so we're just moving the goal posts.

Index fund/ETF/Mutual fund, whatever you want to call it, doesn't matter. If you really care, there's plenty of research out there to find with basic google searches. I'm not going to spend a bunch of time doing everyone's work for them.

Ah that strategy. Look no offense but if you're going to make a claim and then take the lazy way out when someone questions it maybe you shouldn't make the claim. It stifles the conversation. Also the topic being discussed was about what happens if everyone moves to index investing.

You've made the claim that active investors are "front running" passive indices which are just a reflection of whatever happened in the market. When asked for proof you cop out with a "just google it" and then try to make me out to be the lazy one? Ha.

Unsupported claims are just hot air and smoke. I think you're blowin' plenty of both at this point.

You are so lazy that you can't type a few words into google and read it for yourself? There's no reason for me to copy and paste easy to find research on a message board. I have much better things to do with my time. I told you where to find it. This was EASY to find, and there's plenty of additional research that is EASY to find on the topic http://seekingalpha.com/article/232654-indexings-hidden-costs

The arrogance of some people on this message board, who are just flat out ignorant of the finance world, amazes me.

You have a belief about how markets work. Somebody tells you that your belief may be wrong and then tells you where to find the answer. Instead of doing your own research and learning if your beliefs might actually be wrong, you just tell the person giving you information that if they don't provide proof you won't believe it. It seems as if you're just trying to win an argument, instead of getting to the truth. I didn't become a profitable trader by telling people I disagreed with that they were wrong. I became a profitable trader by taking the information that contradicted my beliefs, and then doing the necessary research to determine if my beliefs were right or they needed to be changed. Staying open minded and research/truth focused instead of always trying to be right, is how we grow and learn.

You are making a claim that active investors are front running. Front running is defined as taking advantage of advance knowledge. Your article states that after the announcement the stock price was driven up by trading from active investors reacting to public knowledge. That fails to meet the definition of the term you are using.

So rather than jumping on your high horse of being a profitable trader and calling me lazy for asking for proof of a claim maybe you can provide evidence that front running index funds is a thing instead of providing evidence that people react to publicly available news. Does HFT exist and do they pay for closer locations to the NYSE so that they can execute trades milliseconds before others? Yes. Is there evidence that they are getting advanced knowledge? I have yet to see that. I see that they are reacting to public news faster than a guy at a PC can because they have algorithms looking for the news and information they need to execute faster trades than others.

hodedofome

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Re: As more people index in index funds
« Reply #27 on: April 28, 2014, 11:26:19 AM »
So we're no longer talking about an index fund but an ETF then?

If so we're just moving the goal posts.

Index fund/ETF/Mutual fund, whatever you want to call it, doesn't matter. If you really care, there's plenty of research out there to find with basic google searches. I'm not going to spend a bunch of time doing everyone's work for them.

Ah that strategy. Look no offense but if you're going to make a claim and then take the lazy way out when someone questions it maybe you shouldn't make the claim. It stifles the conversation. Also the topic being discussed was about what happens if everyone moves to index investing.

You've made the claim that active investors are "front running" passive indices which are just a reflection of whatever happened in the market. When asked for proof you cop out with a "just google it" and then try to make me out to be the lazy one? Ha.

Unsupported claims are just hot air and smoke. I think you're blowin' plenty of both at this point.

You are so lazy that you can't type a few words into google and read it for yourself? There's no reason for me to copy and paste easy to find research on a message board. I have much better things to do with my time. I told you where to find it. This was EASY to find, and there's plenty of additional research that is EASY to find on the topic http://seekingalpha.com/article/232654-indexings-hidden-costs

The arrogance of some people on this message board, who are just flat out ignorant of the finance world, amazes me.

You have a belief about how markets work. Somebody tells you that your belief may be wrong and then tells you where to find the answer. Instead of doing your own research and learning if your beliefs might actually be wrong, you just tell the person giving you information that if they don't provide proof you won't believe it. It seems as if you're just trying to win an argument, instead of getting to the truth. I didn't become a profitable trader by telling people I disagreed with that they were wrong. I became a profitable trader by taking the information that contradicted my beliefs, and then doing the necessary research to determine if my beliefs were right or they needed to be changed. Staying open minded and research/truth focused instead of always trying to be right, is how we grow and learn.

You are making a claim that active investors are front running. Front running is defined as taking advantage of advance knowledge. Your article states that after the announcement the stock price was driven up by trading from active investors reacting to public knowledge. That fails to meet the definition of the term you are using.

So rather than jumping on your high horse of being a profitable trader and calling me lazy for asking for proof of a claim maybe you can provide evidence that front running index funds is a thing instead of providing evidence that people react to publicly available news. Does HFT exist and do they pay for closer locations to the NYSE so that they can execute trades milliseconds before others? Yes. Is there evidence that they are getting advanced knowledge? I have yet to see that. I see that they are reacting to public news faster than a guy at a PC can because they have algorithms looking for the news and information they need to execute faster trades than others.

I defined the term in my first example, and then you asked me for concrete examples which I provided in the article and is in the research papers listed in the article. You are the one changing the definition of the term as I originally described it.

grantmeaname

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Re: As more people index in index funds
« Reply #28 on: April 28, 2014, 06:13:31 PM »
Whatever the index is, the point is that a fund which tracks that index must make trades when the composition of the index changes. You appear to be arguing that it's atypical for an index to change its composition at all, but this is wrong, even for total stock market indices.
It's completely obvious which trade is going to happen if it's a case of firms number #501 and #500 in the S&P trading places, and I agree that there is some potential for predictability in that case - though index funds are only a small part of the investing universe and the actual dates the trades are being made are unknown, so at most the "front-running" could be a small bump to the return otherwise found from holding stock #501 or shorting stock #500 over the period. But it's not obvious at all - in fact, I'd argue it's undeterminable - what trades VTSAX or a similar mutual fund is making over a given period because 1) they don't hold every stock that's contained in their relevant index, 2) their index itself is proprietary, and 3) they share the same uncertain timing that the other mutual funds use to prevent front-running.  It's not that the index doesn't change, it's that changes in the index are unclear and changes in the fund are even more opaque.

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Re: As more people index in index funds
« Reply #29 on: April 28, 2014, 06:14:16 PM »
So what's with the shrillness here in the alley lately?

clifp

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Re: As more people index in index funds
« Reply #30 on: April 29, 2014, 01:03:55 AM »
The $10-20 billion cost is spread out across all market participant. I see no reason to think that  Vanguard wouldn't be hit at least is much as average so I'll stick with the .05% figure
You still haven't explained how an index like VTSAX is possible to front-run. There's no announced list of trades, just a portfolio that is as close to statistically equivalent to the market as possible without holding more than 20% of the securities or so.

You should really read the book Flash Boys or even just Google the many interviews with the author Micheal Lewis.

In my best "24" fashion."the following transactions occurred on 4/16/2014 between 11:45:33 AM and 11:45:34 am"
this all happens in flash

VTSAX needs to buy 100,000 shares of GE stock
The current bid for GE 300,000 at $26.00 and ask 200,000 shares is 26.01

The vanguard computer puts out a limit order GE 100,000@26.01
but instead of getting 100,000 they only get 1,000
 bid 299,000 at 26.01 ask 210,000 at 26.02
new limit order GE 99,000 @26.02
This time VTSAX gets 10,000 share@26.02
bid 289,000@26.02 ask 220,000@26.03
new limit order GE 89,000@26.03
this time 20,000 shares get purchased@26.03
bid 269,000@26.03 ask 205,000@26.04
new order order GE 69,000 @26.04
Only 5,000 shares get filled
bid 264,00 @26.04 ask 300,000 @26.05
new limit order 64,000 @26.05
result
50,000 shares bought@26.049
14,000 shares @26.05

So finally VTSAX has its 100,000 shares of GE at average price of 26.042/share.

What is really going on is that 200,000 volume on both the bid and ask is fake/sham bids by high frequency traders front running traders with slower computer connections.
In reality Vanguard was the only big buyer who wanted to purchase 100,000 share and let say Fidelity wanted to sell 100,000 shares of GE along with some smaller seller. In the days before HF trading they would meet in the middle between 26.01 and 26.05 and the 100,000 share would have be exchange at $26.03,  Instead in the next second the process is going to reversed Fidelity is going sell the remaining 86,000 share and being front runned.  (They sold 14,000 shares to VTSAX) but instead of selling for 26.05 like they thought they'll probably end up selling the bulk at $26.00 costing Fidelity fund owners a penny or two.

Now you might think $.012 for 100,000 shares is only $1,200 big deal..
But when you consider that a one professor estimated there were something like 20,000 opportunities to front run  Apple EACH DAY the money adds up.
« Last Edit: April 29, 2014, 03:41:17 AM by clifp »

grantmeaname

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Re: As more people index in index funds
« Reply #31 on: April 29, 2014, 06:48:18 AM »
So now we're talking about HFT and not front-running.

HFT can be mitigated by direct trades with other institutional investors, trading in dark pools, and not buying the shares in the first place - which is how vanguard does much of its purchasing. That's a totally different matter than front-running, and the mutual funds have their own defenses against it.

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Re: As more people index in index funds
« Reply #32 on: April 29, 2014, 07:52:53 AM »
I'm all on  board with HFT should be banned (well, de facto banned via a very tiny tax on each trade that eliminates its value, being my favorite method over introducing lag or anything), but we kinda got side tracked.

None of that is super relevant to what happens when more and more of the market Index.  HFT in order to front run affects every trade, not just indexing (if anything, it likely affects indexing less because most indexers are less frequent traders than those buying multiple individual stocks, or other securities).  It may, or may not, be an issue (and I lean towards it being one), but it's an issue for the market as a whole, not just index funds.
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Re: As more people index in index funds
« Reply #33 on: April 29, 2014, 08:50:39 AM »
None of that is super relevant to what happens when more and more of the market Index.  HFT in order to front run affects every trade, not just indexing (if anything, it likely affects indexing less because most indexers are less frequent traders than those buying multiple individual stocks, or other securities).  It may, or may not, be an issue (and I lean towards it being one), but it's an issue for the market as a whole, not just index funds.

I think the "get rich quick" or more accurately "outperform" siren song of active managers will keep people interested in active investing for as long as the capital markets exist in their current form. The best and luckiest ones will indeed outperform everybody, keeping the allure of active management intact. How could it possibly go away? It's human nature to compete to win like that.

Index investors will consistently only earn average returns, but over time that should satisfy them.

aclarridge

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Re: As more people index in index funds
« Reply #34 on: April 29, 2014, 08:53:12 AM »
I guess it would concern me if we ever got to a point where non-index investors in aggregate beat index investors in aggregate. I wonder if there is a way to check that - one would think that because of fees it shouldn't really ever happen.

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Re: As more people index in index funds
« Reply #35 on: April 29, 2014, 09:03:20 AM »
I guess it would concern me if we ever got to a point where non-index investors in aggregate beat index investors in aggregate. I wonder if there is a way to check that - one would think that because of fees it shouldn't really ever happen.

Yeah, mathematically can't happen, if the fees of the non-index are greater than the index.  Of course if there are no fees (say, a day trader working for themselves) it's theoretically possible, sure.
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clifp

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Re: As more people index in index funds
« Reply #36 on: April 29, 2014, 07:49:18 PM »
So now we're talking about HFT and not front-running.

HFT can be mitigated by direct trades with other institutional investors, trading in dark pools, and not buying the shares in the first place - which is how vanguard does much of its purchasing. That's a totally different matter than front-running, and the mutual funds have their own defenses against it.

No one of the problems (or benefits for HFT firms)  with high frequency trading is front running.  HFT isn't necessarily bad if for instance trades on things like the minor price discrepancies between SPY and the 500 individual stock prices.   Dark pools, are in many ways even worse since there is no transparency into the trades.

I agree with Arebelspy this is a bit off topic. So I'll close with Schwab's (my main brokerage) statement.

Quote
Charles Schwab Corporation Chairman Charles Schwab and President and CEO Walt Bettinger posted the following statement on high-frequency trading at: http://www.aboutschwab.com/press/issues/

High-frequency trading is a growing cancer that needs to be addressed

Schwab serves millions of investors and has been observing the development of high-frequency trading practices over the last few years with great concern. As we noted in an opinion piece in the Wall Street Journal last summer, high-frequency trading has run amok and is corrupting our capital market system by creating an unleveled playing field for individual investors and driving the wrong incentives for our commodity and equities exchanges. The primary principle behind our markets has always been that no one should carry an unfair advantage. That simple but fundamental principle is being broken.

High-frequency traders are gaming the system, reaping billions in the process and undermining investor confidence in the fairness of the markets. Itís a growing cancer and needs to be addressed. If confidence erodes further, the fuel of our free-enterprise system, capital formation, is at risk. We canít allow that to happen. For sure, we still believe investing in equities is a primary path to long-term wealth creation, and we believe in the long-term structural integrity of the markets to deliver that over time for individual investors, which is all the more reason to be vigilant in removing anything that creates unfair advantage or undermines investor confidence.
- See more at: http://pressroom.aboutschwab.com/press-release/corporate-and-financial-news/schwab-statement-high-frequency-trading#sthash.uulmKhcr.dpuf

hodedofome

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Re: As more people index in index funds
« Reply #37 on: April 29, 2014, 10:28:28 PM »
Here's a bit of the other side of the argument on the whole HFT thing http://www.mercenarytrader.com/2014/04/dumb-tourist-michael-lewis-flash-boys-review/

HFT may be bad to some people today, but it's 100x better than what we used to have.

aclarridge

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Re: As more people index in index funds
« Reply #38 on: April 30, 2014, 06:49:52 AM »
Here's a bit of the other side of the argument on the whole HFT thing http://www.mercenarytrader.com/2014/04/dumb-tourist-michael-lewis-flash-boys-review/

HFT may be bad to some people today, but it's 100x better than what we used to have.

Interesting review. I'm not sure I value liquidity as much as this guy does though. When buying things on Craigslist for example, or buying a house, you're dealing with much more illiquid markets, but patient investors usually get a good price.

I agree with him on one thing though, Lewis is definitely sensationalizing the issue and it's hurting his credibility.

arebelspy

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Re: As more people index in index funds
« Reply #39 on: April 30, 2014, 07:42:26 AM »
HFT may be bad to some people today, but it's 100x better than what we used to have.

Uh, no.  We have plenty of liquidity with the Internet without HFT.

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hodedofome

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Re: As more people index in index funds
« Reply #40 on: April 30, 2014, 07:48:23 AM »
Yeah I think the key takeaway is that while HFT might not be the perfect solution, it was a lot worse when people like Goldman Sachs, Lehman Brothers, human exchange specialists/market makers and other investment banks controlled all the trading. It's now a bunch of smaller HFT firms doing what they used to do, and they are probably making less money than the big guys used to. Compared to what my grandpa had to do to invest in stocks...the fact that I can open an account with Vanguard, buy ETFs that are almost free on the expense side, with a bid/ask spread of $.01, and pay $0 commission for it, should tell you how far we've come. To say that markets are rigged...well...they've ALWAYS been rigged by the guys who control the trading execution.  When trading was done in the pits, the rigging was horrendous.
« Last Edit: April 30, 2014, 08:05:39 AM by hodedofome »

hodedofome

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Re: As more people index in index funds
« Reply #41 on: April 30, 2014, 08:07:03 AM »
HFT may be bad to some people today, but it's 100x better than what we used to have.

Uh, no.  We have plenty of liquidity with the Internet without HFT.

I don't quite understand what you're saying. How does your order get executed through internet trading without HFT? HFT is the modern market making.

arebelspy

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Re: As more people index in index funds
« Reply #42 on: April 30, 2014, 08:15:40 AM »
It seems like you are confusing "electronic trading" and "high frequency trading."
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hodedofome

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Re: As more people index in index funds
« Reply #43 on: April 30, 2014, 08:44:17 AM »
Sorry, you are correct that some electronic trading happens without outside HFT firms in the mix. I use the terms interchangeably now but that's probably not correct.

arebelspy

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Re: As more people index in index funds
« Reply #44 on: April 30, 2014, 09:06:14 AM »
Sorry, you are correct that some electronic trading happens without outside HFT firms in the mix. I use the terms interchangeably now but that's probably not correct.

Of course it does.  Remember the 90s?

That's what you should be comparing to with HFT or not.  Not some comparison to what was available to your grandfather, but what was available to us just a decade ago.

HFT is not necessary for electronic trading, or liquidity.  The tiny amount of extra liquidity it provides is irrelevant and useless.
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Chuck

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Re: As more people index in index funds
« Reply #45 on: April 30, 2014, 02:07:04 PM »
If index investing creates a value imbalance, investors will take advantage of it by buying the undervalued stock. Thus the cycle continues onward.

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Re: As more people index in index funds
« Reply #46 on: April 30, 2014, 02:44:58 PM »
If index investing creates a value imbalance, investors will take advantage of it by buying the undervalued stock. Thus the cycle continues onward.
Put another way, the Efficient Market Hypothesis holds only because of the people who operate on the assumption that it doesn't.

hatersgonnahate

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Re: As more people index in index funds
« Reply #47 on: April 30, 2014, 03:15:46 PM »
The HFTers and the Indexers...two warring groups attempting to scoop off the top of active investors, the ones who do the grunt work and take the risk of investing in a company?

clifp

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Re: As more people index in index funds
« Reply #48 on: April 30, 2014, 04:18:30 PM »
Here's a bit of the other side of the argument on the whole HFT thing http://www.mercenarytrader.com/2014/04/dumb-tourist-michael-lewis-flash-boys-review/

HFT may be bad to some people today, but it's 100x better than what we used to have.

I read that guys blog shortly after reading the book. He obviously didn't read the book careful.  Electronic trading has been with us in various form since the 90s. The high speed high frequency trading is a relatively recent phenom 2007 or so.

HF traders provide the illusion of liquidity The actual liquidity the provide is limited to 100 shares or 1 option contract at price typical 1/10 of a penny higher or lower than the bid ask,and for a time that is measure in milliseconds at one exchange (BATS).

Its kinda of a like matador waving a cape in front of bull, suckers the animal into charging, so it can spear the animal as he steps aside. In my example they advertise there 200,000 shares GE available but you can't actual buy or sell them, unless already have another buyer or seller available they can a make profit. 

A market maker provides liquidity in exchange for taking risk he could end up with 100,000 shares of GE only to find the market moves away from him.  The HFT firms take no risk and provide no economic benefit.  (Actually negative benefit but that is a long discussion.)

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Re: As more people index in index funds
« Reply #49 on: April 30, 2014, 04:25:22 PM »
The HFTers and the Indexers...two warring groups attempting to scoop off the top of active investors, the ones who do the grunt work and take the risk of investing in a company?

When you invest in an index fund you invest in the companies the index fund is comprised of too. So index fund investors do have the same risk. It is mitigated by investing in all the other companies.

Also to make up some false narrative that there are these two "warring groups" is a bit silly as there isn't any warring going on between them.
« Last Edit: April 30, 2014, 04:30:29 PM by matchewed »