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Weekend reading: Can we have too much of a good thing with indexing?

Weekend reading

Good reads from around the Web.

We’ve been kicking around the “What if?” consequences of everyone using index funds for years in the comments of Monevator.

But it’s always seemed a very academic debate.

“What if everyone builds their moon home near the Sea of Tranquility? What will that do to lunar property prices? And will they at least upgrade the roads?”

However index fund dominance is starting to look less like science fiction, given the market share gains in the US in the past few years.

Some of our favourite bloggers also addressed this issue recently after famous hedge fund manager Bill Ackman attacked indexing as a “bubble” – and revealed he suffered from a common delusion about how market cap-weighted index funds work in doing so.

Plotting the index funds’ downfall

So this week, Abnormal Returns rounded up what is becoming a fractious debate. (Remember Ken Fisher’s misguided article from last week’s links?)

As Abnormal Returns’ editor Tadas Viskanta writes:

One of the reasons why investors have flooded index funds of late has been because of their lower cost.

At some point this trend will lose steam because index fund fees are already pushing the zero bound.

However active managers are feeling the pinch.

Every major asset manager seems to be either launching a smart beta ETF or actively managed ETF.

Managers who are underperforming the market are finding fault in the indexing trend.

Tadas also introduces what he calls The Bernstein Curve, which looks to plot where index fund market share starts to work against stock market efficiency.

It’s a neat idea, though I think his suggested market share estimate is far too low.

I’d imagine index funds could probably take a 90% share of liquid markets before we saw any big changes in market efficiency.

Market efficiency is a woolly concept though, and nobody really knows.

Zero sum games don’t add up for most

Even if efficiency were to break down, I think most people would still be best off using index funds – because active investing is a zero sum game.

This implies that for every fund manager feasting on the greater inefficiencies we might see in an over-indexed world, another would be losing to the same degree.

And both would be charging higher fees.

Ironic, no?

It will certainly be interesting to see how this all plays out.

If indeed it does play out – as the growth in assets managed by market-lagging hedge funds has surely demonstrated, the desire to invest different remains a strong one.

Perhaps we’ll all become rich before we all become indexers!

From the blogs

Making good use of the things that we find…

Passive investing

Active investing

Other articles

Product of the week: The new 1.14% two-year fixed rate mortgage from Yorkshire Building Society is the cheapest, says The Telegraph. Market turmoil has inched such deals back towards their all-time low of 1.05% from the Post Office last August.

Mainstream media money

Some links are Google search results – in PC/desktop view these enable you to click through to read the piece without being a paid subscriber of that site.1

Passive investing

  • The benefit of saving more rather than investing riskier – Vanguard
  • Regular investing gains from volatility (with a caveat) – Business Insider
  • Swedroe: Small cap works better if you screen out the junk – ETF.com

Active investing

  • Time to buy gold? Here’s how [Search result]FT
  • 10 high conviction picks from proven stock pickers – Morningstar
  • Hunting for bargains in the oil services sector – Interactive Investor
  • The Big Long: HBOS bankers who bet on its bruised bonds – Bloomberg

A word from a broker

Other stuff worth reading

  • Millennials respond to that “save £800 a month” piece [Search result]FT
  • A new tax calculator for the dividend and savings changes – Telegraph
  • Most people are foolishly frugal – The New Yorker
  • An Irish cattle farmer became an expert on Euro Crisis [podcast]Bloomberg
  • Why don’t people manage debt better? – Scientific American
  • There’s been a surge in brilliant US maths students. Why? – The Atlantic

Book reader of the week: Amazon has knocked £20 off its rugged Fire Kids Edition. It expects the little darlings to use it to watch Disney movies, but who knows, perhaps they’ll start reading Monevator?

Like these links? Subscribe to get them every week!

  1. Note some articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”. []
{ 30 comments… add one }
  • 1 Malcolm Beaton February 20, 2016, 12:01 pm

    Hi All
    I think it was John Bogleheads of Vanguard that said only 99.9% of Stockmarket transactions were investment related -the rest were traders trading with each other -used to be called gambling!
    I think we could do with a lot more indexing,less gambling and more investing

  • 2 Passive Investor February 20, 2016, 1:56 pm

    Interesting article and like you I suspect indexing could take a very large proportion of the market before it becomes unsustainable. I don’t really understand the mechanics of stock markets enough to be sure but doesn’t the issue boil down to liquidity rather than efficient price setting?

    By this I mean that perhaps as few as a 100 analysts could set the ‘correct’ price of a share. The analogy is with a cake weight guessing competition where the average of 100 guessers will be a lot closer than the average of 10 guessers. But the average of a 1000 guessers won’t be much better than that of 100.

    So (thinking on my feet) perhaps the ratio of total indexed capital vs total active capital isn’t the important factor. What is important is the amount of new indexed capital coming into the market in a day (or leaving if there are net outflows) compared with the total amount of capital being traded actively over the day. As indexed capital perhaps doesn’t get traded very much (it tends to be ‘bought and hold’) compared with active capital isn’t it possible that the proportion of indexed capital could be very high indeed (? 99% ?!) provided what active capital there is being traded VERY actively.
    Interested to know what you think and thanks for raising what is an under-addressed point in my view.

  • 3 Planting Acorns February 20, 2016, 2:42 pm

    Sometimes it seems to me that this argument assumes the indexes that are tracked are somehow written in stone… In my lifetime is it not possible that a passive investment could hold every listed share, bond, treasury in the exact proportions of their weighting ? Some of your older readers must look at what’s achievable today against what happened in the 70’s and think they seem impossible…

    If so, capital rushing into particular assets once they joined an index would cease to be a problem…

  • 4 Planting Acorns February 20, 2016, 2:43 pm

    Sorry, seemed impossible*

  • 5 Gregory February 20, 2016, 3:43 pm

    Barry Ritholtz: passively managed assets are still a drop in the ocean. “There are about $60 trillion dollars in liquid investable assets worldwide. Once you start bringing in non-liquid assets like art and collectable cars and jewellery, you can add another $20 or $30 trillion dollars in. We’re not even talking about real estate, which is another God knows how many tens of trillions of dollars. The index holdings of Vanguard are about $2 trillion. Add another few iShares and BlackRock indices, and what are we up to? $3 or $4 trillion? Out of 60 trillion it’s almost minor.”http://www.evidenceinvestor.co.uk/calm-down-activistas-passive-is-a-drop-in-the-ocean/

  • 6 Gregory February 20, 2016, 3:51 pm

    How long will you wait for Smart Beta to work? – “The market can stay irrational longer than you can stay solvent.” Keynes. Never forget: no pain no gain. Keynes knew it and he was right. http://awealthofcommonsense.com/2015/01/keynes-fired-money-manager-today/

  • 7 Learner February 20, 2016, 7:23 pm

    The FT £800 saving article was an artful troll. Hey kids, if you’re not saving 50% of your pay you’re dead! Knowing full well that very few will be able to afford it, let alone do it. Really not constructive.

    I see they will be starting a regular column on money issues for Millennials which might be interesting.

  • 8 The Investor February 20, 2016, 8:48 pm

    @Learner — Hello! Respectfully, I disagree, I’ve rarely if ever seen the FT troll like that and I think they wrote it genuinely from their ivory tower. I see so many mathematically inaccurate “it was just as hard in my day” comments here and elsewhere from 40-60-year olds — and I don’t see at least the older FT editors being any different. I really don’t believe the older generations get how financially disadvantaged the youngest (up to 35s, say) are, at least under current norms.

    (i.e. Maybe the millennials will eventually roam the world while robots do the work etc — I say slightly tongue in cheek 🙂 — but in terms of marriage, two kids, own their own home, at least without being a personal finance and investing ninja.)

    Of course, some oldies answer “it’s okay, because there’ll be a big crash of some sort”, which is fair enough, but not really a denial that things* are pretty screwed as they stand.

    *Again, where ‘things’ are buy a decent property to live in and bring up kids with 4x your professional salary and no significant help from mum and dad south of Nottingham, while also beginning a pension and having some life.

    I’ll now wait for some older gents to turn up and tell me owning your own property isn’t the be all and end all — from the comfort of their own properties that have delivered a geared return of 20-50x over the past couple of decades. 🙂

  • 9 The Investor February 20, 2016, 8:51 pm

    p.s. I say “gents” because they invariably are, at least as far as I can tell from usernames.

    p.p.s. Also, I can buy somewhere and I am not currently minded to set up a home with a life partner and 2.5 kids, so not entirely talking my own book here. Plus I’m sadly decently over 35. 🙁

    p.p.p.s. Although better sadly over 35 than the sadder alternative, as Woody Allen almost said.

  • 10 david February 20, 2016, 9:57 pm

    Ackman’s anti-index-fund rants are pretty hilarious in the context of his massive over-reliance on Valeant for his returns. If he did sensible equal-weighting for his stock-picks and avoided blow-ups I’d have more respect for him.

  • 11 MyRichFuture February 20, 2016, 11:38 pm

    On the subject of an index investing tipping point, I honestly can’t see this ever happening. Most humans will always chase higher returns because they see being average as failure.

  • 12 Learner February 21, 2016, 12:39 am

    @TI, I don’t know which is worse – that the FT could be so out of touch, or that they know exactly what’s up and exploit it with clickbait headlines 🙂 Also factor in the readership demographic which can be surprising.. an NY Times writer recently mentioned that the *median* NYT reader has a household salary of $156k and just over $1m in assets.

  • 13 Jim McG February 21, 2016, 9:53 am

    Thanks for the link to the FT article on the pensions. Very entertaining. But all I can say is that if “the Millennials” keep inventing phrases like “the gig economy” to describe how their approach to work is different, they deserve all they get.

  • 14 The Rhino February 21, 2016, 1:09 pm

    Even RITs at it with his latest offering on millenials. How dare they pretend to be victims of circumstance!

  • 15 Mathmo February 21, 2016, 2:43 pm

    Thanks for the article and links this week, TI.

    I loved the FT article and related responses. I agree it’s not trolling, but I also think it’s not ivory tower thinking. All they did was do the maths and lay it out. If you want a decent pension, then here’s what you need to do.

    And the riling against the article is merely the shock of seeing the truth laid out and the sound of thousands of alarm clocks going off. That and a lot of very good cat memes as the generation hits snooze and hopes it will all be different by the time they are forty. Good luck kids. Let them not say that noone told them.

    I recall as a 20-something, I had never had so much disposable income, nor since, as it seems ones commitments are exponential whilst ones income is merely polynomial. I wish someone had sat me down at 21 (as I brandished my Cambridge maths degree) and explained how compound interest was going to affect my life — all I had was a vague notion of Micawberism and that saving was moral. Hardly a substitute for the cold calculations laid out by the FT.

    Some lovely thoughtful links this week — the Raptitude article echoing your beautiful mid-week piece on appreciating what we have.

    And a salutary lesson in from our mad predictor in the iii article — how I’d love to believe he is right and so I feel my scepticism lifting. And then I ask what facts he has. I suppose I’ll can hope the next big bull is coming, but I don’t think I’ll bet the house on it. Be disciplined when others are greedy…

  • 16 Planting Acorns February 21, 2016, 3:04 pm

    Hey all, surprised the FT article is attracting so much attention… As it has I might as well throw in my two penny’s worth…

    I’m 33, bought in September 2007…I genuinely think the ‘drawbridge’ was pulled up in November of that year… I couldn’t possibly hope to own my home now, and people who say ‘it was just as hard in my day…’

    …I wasn’t around but take my lodger for eg… He’s 28, earns tiny bit less than me but spends a chunk of it renting my spare room out Mon- Friday. He goes back to his parents in the Midlands at the weekend… Now he’s out of his probation period he’s looking to rent a room full time at £700 a month (most don’t have shared lounge) or spend what he saves in rent on rail fare… I do feel for them…

  • 17 Edmund Blackadder February 21, 2016, 5:23 pm

    I’m fascinated by the commentator on the FT article who said s/he can’t buy a house because their student loan repayments are higher than the average mortgage for the area. What’s s/he earning? £100,000?

  • 18 L February 22, 2016, 1:18 pm

    @ Jim McG

    Why the assumption that a millenial coined the phrase “gig economy” and why does the coining of silly phrases mean that millenials deserve their terrible fate? Lord knows silly phrases have been around for a wee while. Still, ‘keep calm and carry on generalising’ 😉

  • 19 dearieme February 22, 2016, 3:20 pm

    I think “gig economy” is rather a neat summary of the life of the contractor working through a personal service company.

  • 20 @algernond February 22, 2016, 4:43 pm

    ‘……all-time low of 1.05% from the Post Office last August’
    Just to let you know, that’s not the all time low for mortgage rates.
    I’ve been paying 0.99% since BoE rates went down to 0.5%

  • 21 Learner February 22, 2016, 6:59 pm

    @dearieme, agree – contractors are certainly part of the “gig economy”. There’s a quite a difference between a professional consultant with their own company and a pseudo-employee of Uber, JustEat, etc though.

  • 22 Planting Acorns February 22, 2016, 7:19 pm

    @learner – I wonder how many people using psps are truly consultants and how many are employees by another name? Glad the govt is signalling an intention to level the playing field between psps and PAYE with the divided changes…bit of luck it’ll get equalised and PAYE people won’t have to pay more, any more.

  • 23 Planting Acorns February 22, 2016, 7:20 pm

    Psc sorry – phone is thinking of the little handheld computer

  • 24 Mathmo February 22, 2016, 7:56 pm

    @PlantingAcorns — indeed — it wouldn’t do to encourage entrepreneurs to found companies, employ people and make profits. They should be dissuaded at all costs! Pesky PAYE avoiders, propping up growth in our economy. The only thing that should be tax-free is when the nice rich people invest in them.

    It’s already illegal to masquerade — for tax purposes — as a contractor when you are an employee in all but name. For people who own their own company, PAYE has a second issue that you are also paying all the Employer’s NI – so the immorality of the separation of NI and Income Tax is tripled up. Hard to get out of bed when your marginal tax rate is 45.8% above over 10k a year (progressive tax system, don’t make me laugh!). And if your business is VAT-able and you’re the input, then you’re looking at 65.8%. Plus business rates (approx 50% of rent). Should you actually make profits that’s another 20% gone. And then dividend tax on top too! Whoopee! Also – get any of this wrong and it’s off to the Big House with you.

    Being a wage slave is easy street: PAYE is a small price to pay. The grass is always greener. Rant over!

  • 25 Planting Acorns February 22, 2016, 8:51 pm


    I fear I’m already at the point where I’m going to get admonished for provocative comments…

    …but if using a psc was as onerous as you describe why would so many people use them then sit next to employees and do the same job, eat at same canteen etc etc

    … I’m glad they’re closing the loop hole. Easy to say ‘someone else’ paying more tax is a price worth paying

  • 26 Learner February 22, 2016, 9:15 pm

    Well they sit next to them 10-11 months of the year anyway, when the real employees aren’t on paid vacation or sick leave or company paid training.

    Of course earning about double what the permanent staff do rather takes the edge off..

  • 27 The Investor February 22, 2016, 11:22 pm

    I’m sympathetic to the government/HMRC/employees’ frustrations with PSC contractors who are employees in all but name, as much because employers are exploiting the system as contractors are. I have several friends who’ve earned a fortune as contractors working at one firm for several years. An external observer could not tell the difference between them and an employee.

    The trouble is the new dividend tax hits all different nails with the same hammer.

    I work on my own time in own premises, bill multiple sources, pay various sub contractors, manage cashflows, have no paid holidays etc, spend 3-4 days a year on accounts/billing etc, and I’m being hit just the same.

    I’ll likely press on because I get claustrophobic when employed, but I absolutely did think maybe I should swap it for a 9-5. (Which as has been said has it’s own problems of course, grass greener etc, but regular salary, paid 5 weeks hols, and matched pension contributions go a long way…! 🙂 )

  • 28 P February 23, 2016, 9:39 am

    > if using a psc was as onerous as you describe why would so many people use them

    Cos they are given no choice. The position of employee is just not offered.

  • 29 The Investor February 24, 2016, 8:31 am

    @mathmo — Forgot to say in response to your always enjoyable reflections on the links that I had a similar chain of thought with respect to the stock market oracle interviewed by Richard Beddard. As you know I don’t always agree with the content I link to, but I do hope they provoke some thought, as that’s the criteria for me. With that article, I found it thought-provoking in the same way that listening to the album Astral Weeks as a student was — trippy and strangely life affirming, but definitely not a report from the front line of kitchen sink reality…!

  • 30 Mathmo February 24, 2016, 4:32 pm

    But by golly I hope it’s true.

    *glances at FTSE hurtling towards 5,500 again*

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