When I was in YC Garry showed me how to be a founder. After YC Garry showed me how to be a more compassionate human to myself and others. I'd recommend everyone check out the inner work Garry has also achieved beyond his external achievements.
I think Warren is fantastic but I feel like her argument for Amazon is flawed and I'm curious to hear counter arguments.
In her example of Amazon being a platform and information aggregator, wouldn't a brick & mortar grocery chain like Safeway/Vons/CVS be guilty of the same anti-competitive practices when they sell "Safeway Brand Fruity Os" next to Kellogg Fruit Loops?
Businesses seem to have been able to be platforms and information aggregators for a very long time and we've had plenty of innovation and competition
IMHO, your analogy is exactly correct and if Safeway was as big as Amazon, Warren would be calling for them to be broken up too.
On the other hand, maybe the analogy isn't good because safeway displays products side by side while Amazon can more easily promote their own products. Level on a shelf has much less effect than a product being out of sight at the bottom of a webpage or even the second page of search results.
Grocery store margins are razor thin though, they compete with each other a lot.
But as a percentage of their perspective markets Amazon is larger. The grocery/homegoods industries are very competitive. Think about how many alterantives you have to walmart.
How many places do you routinely go to order things online? How many places do you go for groceries? I bet you have at least three options. Walmart, Regional grocery store, and Target or some other alterative place like trade joes.
Amazon's ability to affect customer behavior is much stronger than walmarts I would argue.
edit: and maybe Walmart _should_ be broken up, just not as high visibility an issue.
That’s not a reason to break the groceries or platforms up. Just ban them from producing their own brands if they’ve provided a similar competitor product for years. Although ironically, then the govt would be anti-competition
that's not how anti-trust issues are dealt with in the US, conglomerates are broken up so preserve the value of the existing buinesses but break the monopoly, not just legislating a business line out of existance, Bell telephone into a bunch of smaller providers for instance.
Hilarious. The icon for the _entire category_ of social-networking-sites uses Facebook's logo. Unless I'm mistaken. No other category uses the logo of just one brand to denote its category. Now that's mind-share. Category penetration in 2012: 61%, in 2018: 70%. Oh dear, oh dear.
IMO there's a difference of scale - Amazon has quasi-monopoly power in the "buying things online" space, so much so that e.g. Anker, which makes cables and chargers and competes directly with Amazon Basics, has no distribution channel other than Amazon.
If I make Unprovable Loops ("Part of this Turing-complete breakfast") and I'm not satisfied with the distribution deal I get from Safeway, I can always call up Von's or CVS or Target or Whole Foods or Walmart and see what they'll do, and in most cities there are multiple such options.
I do wonder if the problem here is inherent to being an online store. If there's a Safeway in one part of town, a new Walmart in another part of town will sell roughly as much cereal as a second Safeway. But if Amazon.com exists and is generally useful, why would people go to another site? So perhaps some of the traditional/historical safeguards against any one store becoming a monopoly on the market no longer apply.
Walmart, Costco, and Kroger are bigger than Amazon in terms of revenue. (Kroger only just.)
> But if Amazon.com exists and is generally useful, why would people go to another site?
Why wouldn't they? What's stopping them?
I agree we may need to reconsider some of our laws to better take into account online behaviour. But Amazon should not be penalised for mere success. They ought to be penalised for abusing market dominance if that is indeed what they are doing. No abuse, no penalty. Questions about tax payments on the other hand… Amazon have nowhere near the quasi-monopoly in their sphere that Microsoft has in desktop operating systems, Google has in web search, and Facebook has in social media.
When I was a 21 year old with a fledgling startup, Geoff kept a promise to me several years later that he definitely didn't need to and had barely any incentive to. He did it because he is a man of his word and I owe much of the opportunity I have in my career because of his integrity and that choice to keep it. Congrats Geoff! And THANKS!!!
This is fascinating. Selfishly though this seems to signal for investors of index funds (such as myself) that they will only continue to be good investments unless major government regulation occurs.
Does anyone know of any investment risk to index funds if everyone is now doing it?
The risk is because index funds don't do stock analysis (instead they buy and hold all stocks) they will invest in bad companies and prop their price up. Then when the bad company goes bankrupt (as everyone paying attention knows will happen) the index funds are left holding all the stock suddenly worth nothing.
Which is to say the traditional more expensive managed funds that actually pay attention to the fundamentals of the companies they invest in should see a comeback. While this style of fund is more expensive (because a human can only examine a few companies in a year in enough detail to decide if they are worth investing in - as a full time job you can maybe do 50) by investing only in companies that will do better than average they can beat the market (or shorting if you want to play companies that will do far worse than average). So far the low costs of index funds have made them a better investment despite them not investing in strong companies, but we should see the day where a managed fund can beat the index funds just because the index funds are leaving the advantages of analysis on the table.
You can argue [meaning this might or might not be correct] that historically managed funds have done worse than index funds because there are so many managers that anytime there is a slight deal someone jumps on it before the deal is large enough to pay for the costs of finding it. However if you don't jump on it someone else will and they make something on the deal while you make nothing. Thus as index funds take over there will be more and more deals for the managers to find, and managers can wait until they are large enough to be worth the price.
It will be interesting to see when/where the line is crossed.
I think this is almost true. It would be true if index funds held all the stock. But since they don't and managed funds still exist, the stock price will go down when managed funds decide to sell. When the stock price goes down, the shares become a lower fraction of the index, so the index funds will also sell some.
I think the main point is that index funds still rely on traditional market players to effectively allocate risk. And as index funds take up more of the market, they become less able to do that. Right?
The index fund doesn't need to take any action to respond to price movement. When the stock price goes down, the shares become a lower fraction of the index and also a lower fraction of the fund's holdings.
The fund has to manage holdings around fund purchases and redemptions, and when the index changes.
This is not exactly true. Many (most?) indices are market cap weighted, so if a company’s stock is tanking (i.e, their market cap proportional to other tickers in the index is going down), the index will sell the shares.
In my view, index funds aren’t really passive at all, they are crowdsourcing the best ideas of active management. This is why many indices (like S&P 500) produce pretty good returns.
If you created an index held every US equity in equal proportions, regardless of price movement, that would be like what you’re talking.
If you compared the returns of the S&P 500 against this theoretical index (let’s make it an ETF and call it “DUMB”), you would find that the S&P 500 would have much better returns.
The takeaway from this is that many indices produce stellar returns and aren’t as “passive” as one might think. Think of factor indices or whatever.
The point is that the stock won't always tank when they're doing something that'll negatively affect fundamentals, because too few people are actively researching & investing in the stock to affect the price. And then when a tipping point is reached and the stock price starts to go down, index funds will exacerbate the slide as they rebalance out of the falling stock and sell off its shares.
Normally markets remain efficient because they provide an incentive for people to actively research & surface all available information on a company's future prospects. If most people aren't doing this, then a.) the market price will be slower to react to bad information about the company and b.) people who do actively react will make larger profits, as they can trade on their information before the majority of the market takes it into account.
There's an equilibrium level of disequilibrium - as more people pursue passive investing, returns to active investors rise, until some of those passive investors realize they can make large profits as active investors, restore market efficiency, and destroy the profit potential of active investing. I'm not sure exactly where we are in that cycle, but there's some evidence that stock prices have become less volatile overall except for major news-related panics, which would be expected if a large proportion of people are passively investing.
The caveat is that doing active management can get expensive in a hurry, which is why traditional funds tend to underperform index funds. It's cheaper to have some simple rules that a computer can execute and occasionally eat losses than it is to hire a bunch of experts to do tons of work to avoid those losses and end up costing more than you would have lost.
Ultimately the problem domain of monitoring every publicly traded company and prognosticating their actions is huge, and the job is so messy that it will never be cheap. There should be an information theory paper on this somewhere.
Index fund investors are classified as "passive investors," while others are "active investors."
The main investment risk to index funds growing is that, if everybody is a passive investor, then the passive investors are worse off as there are very few active investors who actually try and value companies appropriately.
On the other hand, if the market is littered with active investors, then the market is likely more efficient and 'correct', and so you're (probably) better off as a passive investor.
As an "active investor" your competition is HFT algos on servers located as physically close as possible to the stock market in order to achieve superhuman reflexes. Which you have absolutely zero hope of beating.
I'd rather see slower, predictable gains than bet my nest egg trying to go toe-to-toe with hyperefficient machines -- or hand it off to some Manhattan finance bro making that bet on my behalf.
I'm going to upvote your comment because I don't think it deserves to be downvoted, and at the time of writing it's grayed out for me.
That being said - you're incorrect about about competition between active investors and HFT. That's a common misconception. HFT primarily occupies a marketing making role, which means they try to play both sides of the spread very quickly for a very, very small profit on each trade. There are elements of valuation here, but what's really much more important is very small holding times and low latency turnaround. The ideal goal of an HFT operation is a trading strategy which earns a profit 51% of the time and trades very frequently.
In contrast, active investors - whether quantitative, fundamental or some mix thereof - care more about being correct on fewer bets, which have more money behind them and which are held for longer periods of time (hours, days, weeks or months). These funds are not competing with HFT: HFT only competes with HFT. This is because HFT activity and active investing activity are completely alien to one another. HFT has a material impact on the profit margins (slippage), volume and liquidity available to active investors, but strictly speaking they don't actually compete (except in the narrow sense that you "compete" with a car salesman to buy a car for a better price).
HFT is a relatively tiny portion of the financial industry which gets outsized attention. It's generally more accurate to think of HFT firms as financial utility providers rather than investing firms.
HFT is basically a tax on each transaction that gets applied because you don't have as accurate a view of the market as the guy who is down on the wire. If you're strategically buying shares in a company and holding them then HFT is not your competitor.
If you're a day trader trying to flip stocks by holding them for a couple of seconds at a time HFT is why you're bankrupt.
But it's also not true that HFT folks create markets. To create a market you need to sit on shares and offer them for sale. HFT leeches off of existing markets. It's true they offer share for sale, but only ones they bought a few nanoseconds earlier for the original price.
Day traders flipping stocks every few seconds won't lose money because of HFT firms, they'll lose money because of trading fees. Trading every few seconds is a wildly unrealistic strategy for most people to pursue on their own. On an average, per-trade basis the fees associated with buying and selling are several orders of magnitude higher than the profit margins of any HFT strategy. The only way your fees will even come close to the profit margins of an HFT are if your volume is such that you've become a market maker yourself. This is a very basic and fundamental tension that precludes HFT from being a competitive force to other traders engaging in speculation and investing.
Your final paragraph strikes me as ideologically bent, particularly with your use of the word "leech." It's an uncontroversial fact that HFT firms facilitate market making. HFT firms do sit on shares and offer them for sale. Most often they do this quickly, but occasionally they have holding times with longer horizons. What's more important than the turnaround time is the low latency with which they execute orders. Definitionally, HFT is engaging in market making because when someone wants to purchase a share, an HFT is ready to sell it to them. Likewise when someone wants to sell a share, an HFT is ready to buy it from them. This is quite literally, "making a market."
In point of fact, your hypothetical day trader would not be capable of buying shares every few seconds if it weren't for HFT (inadvisable though it may be). How do you propose they'd achieve the same kind of liquidity otherwise? By calling a broker? There are far fewer market makers than there are active investors. Passive investing activity with index funds also dwarfs the scale of HFTs. The straightforward conclusion that follows is that fewer, faster parties must exist to make markets for the many, comparatively slower investors.
This is an extremely well-studied subject; when you peel back the pomp and PR about HFT as an industry, you'll encounter an incontrovertible reality. There is no way to service modern trading activity happening every second without the HFT activity that happens every microsecond. By calling that latter activity "leeching", you read more like someone delivering an opinion rather than a cogent, well-informed and substantive criticism.
At the end of the day how much position does a HFT firm hold? If nothing has gone wrong it is zero.
Just because they're stuck holding the bag on trades that end up being cancelled sometimes and have to wait for them to unload doesn't means they're making markets. If a market doesn't already exist the HFT firm is not going to create it.
They absolutely do increase the volume figures on markets, and that can be interpreted as making markets, but it's not an accurate representation of the big picture.
> At the end of the day how much position does a HFT firm hold? If nothing has gone wrong it is zero.
This is also incorrect. HFT firms routinely hold positions for days and weeks. It would be inefficient and strange to literally deplete all positions and begin fresh anew each day. Executing orders with extremely low latency is not equivalent to be perfectly symmetric in buy and sell orders.
I encourage you to learn more about the topic you're talking about, because what you're saying is substantially at odds with how the industry actually works. At this point I'm curious how you would define market making, because it's very ironic for me (and anyone else reading) to hear you say these things and talk about what is or is not "an accurate representation of the big picture."
That's why being a passive investor is often the best route for the average person, unless you have the opportunity to invest in a successful fund that takes an active role, or you put in the effort (and have the skill/luck/whatever) to invest yourself.
I'd point out, however, that your competition is usually not "HFT algos on servers located as physically close as possible," unless you are, yourself, a HFT trader. Even if you're buying a security for a few cents more because an HFT firm has corrected the price, if you're holding for weeks, months, or years... what's the difference? There's room for both of you to succeed, as long as your investment philosophies and holding periods differ that significantly.
Stock pickers managing active mutual funds aren't competing with high-frequency traders at all. The human stock pickers are buying with the intent to hold for at least several days (usually even longer).
If you want slow, predictable gains then invest in highly rated bonds. Handing investment decisions off to some Manhattan finance bro is unlikely to improve your long-term risk-adjusted returns.
There are active investing strategies besides HFT. One example is Buffett-style value investing, where he picks a few good businesses with large moats and great cash flow and then holds them for decades. This is about the polar opposite of HFT (where you hold for seconds and don't care about the underlying business at all), but both fall under the general category of active investing.
> As an "active investor" your competition is HFT algos on servers located as physically close as possible to the stock market in order to achieve superhuman reflexes.
That's usually not true at all. HFT makes up a huge portion of market volume, but for almost all investors is basically negligible to their return, despite what Michael Lewis might scare you into believing. HFT firms make a comparatively small profit in the universe of Wall Street, so they aren't eating your returns.
That's not to say actively managing your money is not difficult. You're mostly competing against sophisticated investors and firms with a far greater capital and knowledge base than you. It's just that in general, the majority of capital being bet against you is not from High Frequency Trading
I'd say this article probably overstates risks. US Equities are only about 30% passive, depending on how you measure it, and there probably is substantial run-rate for an even greater concentration.
one risk is that if too many people are invested in index funds (passive, not buying or selling based on new information), then the price of those stocks is determined by a small group of active investors
So long as the pool is large enough that doesn't matter. Index funds just need the price to be close to reasonable to work out. When the price is not reasonable index funds do well. In general active investors work to push the price to reasonable levels.
Of course there is such a thing as price manipulation which active investors can try - if there are only a few and they work together this can work out. However the investors have incentive to cheat when working together as the cheater wins against his peers, thus this currently is confined to "penny stocks" (for example the company behind the stock doesn't exist anymore but they didn't properly delist their stock so technically it can be traded - you can buy such stocks for say a penny each and then hype them to suckers as the next big thing and sell for 10 cents each and make a killing - since the company doesn't exist no one else pays attention and the scam works.)
A risk is one of the options, which is a breakup of existing funds: "Force giant index funds to spin off their assets into a number of separate entities, each independently managed. Such a drastic step would—and should—face near-insurmountable obstacles, for it would create havoc for index investors and managers alike."
So long as the two broken up funds are both index funds it won't matter. Index funds all work the same way so a million tiny funds will have the same effect as one large one.
Theoretically, yeah, but like a lot of tech companies, index funds are a high-ish fixed cost and low marginal cost business. The staff/IT/compliance/etc. costs to run a fund don't scale linearly with invested assets so functionally a million tiny funds would be much more expensive to operate (collectively) than one big one. You'd have to have somebody at each fund voting in all those shareholder votes, right?
I believe breakups would drive up the expense ratio which is why Bogle said that it would be damaging to individual investors. Part of the reason why Vanguard is so cheap to operate is because of its size contributing to economies of scale. You can see small variations in the expense ratios now (for example Fidelity is slightly higher cost than Vanguard across most apples to apples comparison funds) for this reason.
I don't consider myself very savvy in investing, but I guess if "half of all stocks" are owned by index funds that's a concentration of ownership that might be considered unnatural at best.
I didn't read past the paywall but one good thing if more and more people own index funds then they are participating in the success of those corporations represented in that index. Might tend to tone down some of the shrill agitation that everything "corporations" do is evil and greedy.
Hey! I've been trying to find positive stories of people who sacrificed work for deeper personal lives. Would love to chat with you over email if possible! My email is brian@teamleada.com
Although there is still tons of money going to actively managed funds it seems to be more and more common knowledge that index fund investing is ultimately the smartest thing to do for personal finance.
Does anyone know what the risk factors are (if any) to this type of passive investing if EVERYONE begins to do the same thing?
I had an interesting conversation with a very smart investor last year, and basically his idea was that while active managers will sell certain specific stocks (less volatile stocks) to fulfill redemptions in the event of a decline and/or crash, ETFs will generally just hit an (automated) sell on everything across the board. So proportionally they will sell off significantly more volatile small and midcaps vs large caps.
Every since I have had that conversation, I no longer invest in passive index funds or ETFs.
>>basically his idea was that while active managers will sell certain specific stocks (less volatile stocks) to fulfill redemptions in the event of a decline and/or crash,
This is true and leading to very good insight.
>>ETFs will generally just hit an (automated) sell on everything across the board. So proportionally they will sell off significantly more volatile small and midcaps vs large caps.
This is absolute nonsense and something you hear from active investors pitching you an anti-index fund strategy. Index funds and ETFs tracking indexes will not have some absurd sell off that disrupts equilibrium, they will... just proportionally adjust to the index, since that is what they do.
Did your smart investor friend go into detail how this massive disruption could occur (what conditions would cause such a cyclical crash, because the only thing we have in our past that even comes close is the Great Depression, and had index funds existed then, it's not likely this activity would occur) or what the details are?
This is incorrect, especially with ETFs. With an ETF, the seller/buyer (the individual, not the fund) pays all of the transaction costs. So buying and holding an ETF doesn't expose you to the problems which the behavior of panicking investors^. The same is not always true for mutual funds.
caveat: Vanguard index funds may be special and this doesn't apply to the same extent because the ETFs are a dual share class of the larger mutual fund.
But you are still exposed to the market, which can decline significantly. People will withdraw money from their passively managed funds when the market starts tanking. We have no idea what will happen in the next 'fear trade' when everyone starts dumping shares.
Stocks can go crazy and this could create a death spiral on the ETFs, because an ever more frequent decline can lead to significantly more volatility in small and midcaps, and more people withdrawing funds from their ETFs, which in turn will cause more liquidations.
All reasoning (to some extent) is lost as to which assets to liquidate. Actively managed funds will generally liquidate assets that don't cause too much swings in share prices in a downturn. Liquidating $50MM worth of Google won't make a big difference, but liquidating $50MM worth of SmallCap generally will put significant pressure on the share price. On the flipside: imo it does create a significant buying opportunity when it comes to small cap stocks.
Tl;dr: in my view, the more money that ends up being managed passively, the easier it will become to beat the market as an active investor.
There are two concerns: transaction costs (tracking error relative to index return) and index return.
Those who believe in generally efficient markets want to capture the market return, however volatile, with as little tracking error as possible. Since the ETF holders don't actually sell any stocks when the prices decline, their returns are temporarily depressed. If and when prices recover so too will their value.
There is nothing unique about ETFs in this respect. Your critique is more about index funds in general, not ETFs specifically. ETFs practically differ from mutual funds only in things like transaction costs.
re your tl;dr: Sharpe's theorem shows that active investors will underperform passive investors after costs. Notice that this does not depend on the number of passive investors (and certainly at this point we're nowhere near any of the percentages of passively managed assets which people say may be worrying).
Overall, I do not think your critique is well-informed by the facts.
To each their own investment style (and there are many), but markets (in my view, and in the view of many others) are not efficient. (More than) half of what determines the stock price is psychology and herd mentality. It's not just numbers, and more an art than it is a science. Larger cap stocks however are generally priced more correctly than small- or mid cap stocks.
Second to that is that your returns will also depend on the risk you are willing to take. Investing through index funds and ETFs will correlate with a certain alpha, but that doesn't mean returns can't be higher if you are less diversified (and thus taking more risk).
Depending on the type of companies you are investing in, you might be comfortable taking a bigger risk with the goal of achieving a higher return.
Say you're working in technology and truly understand it, you can probably outperform the market significantly by investing in 3 to 5 technology stocks. Is it riskier? Yes. Is it worth it? Some people will say yes, others say no. And that is absolutely fine.
So Buffett's $1M bet wasn't enough to convince you that passive beats active?
Hedge fund are basically a compensation scheme masquerading as some sort of smart money management thing.
What's great is that the debate of passive vs active will go on forever - There will be periods where one outperforms the other - sure. But in the end, net of fees - active cannot win consistently, on average. Its human nature to believe we can beat the casino.
Congrats Garry!