One of your new subscribers here. Found you through The Free Press.
Almost feel I’m at AA. Hi my name is Pat and I’m a Passive Investor. So this being one of my first pieces to read on your Substack piqued my interest and caused a little concern. I have tried to learn about investing but it seemed like this huge enigma. So I just did the usual thing, put money in my 401K but only knew enough to be dangerous about which funds to put it in. Then came along a colleague with “The Little Book of Common Sense Investing” by Bogle (you know the guy who started the index fund fad or now should it be index fad funds?) Throw in reading the “Psychology of Money” whose author’s name escapes me and now I am all I with passive index funds.
I do like educating myself but with limited time I need short, simple information that is impactful for a small time investor (primarily for retirement but wouldn’t mind getting a better rate of return) who is willing to wade into medium risk investment (I’m mid 50’s).
Any possible way you could steer me toward sites to help with the above info in mind? I plan on checking out more of your posts and the gentleman you recommended in this one.
I’m not looking for you to manage my funds or set up tutorials for me but even if it’s “hey go this site and they have some good info for newbies” would be great.
Anyway enjoy your take on things with the bits of sarcasm through
PS don’t know the name of the beach but hope it was with the hike
I don't know that you need to feel concern. The thing with passive is that it might be bad for society as a whole, but it can still be a good way to make money. Provided that money keeps going into passive, it will continue to create a situation where indexes do well. Just look at today, for example. For months and months many smart investors have been talking about a market collapse. Those smart investors (generally speaking) have been going short or simply staying in cash, all the while people just staying in passive funds have done fine. SPX at 4k pretty much. That could change any moment of course, but it shows how passive certainly can be OK.
The book "Richer, Wiser, Happier" is fantastic, a strong recommendation from me. And this YouTube channel has loads of excellent content geared at people who are newer to markets
I think I found you from a Twitter link, but I'm not sure. I am always looking for legitimate insights and discussion on a range of topics and I really appreciate that thoughtful, smart, and talented people are sharing their thoughts and steering me to the network of similarly inclined people that they value.
I am a mostly passive investor who aspires to find and reward good companies with good ideas, but the time to evaluate and follow individual companies eludes me.
The abstraction and separation that you paint with passive investing reflects these same trends at more micro levels throughout human endeavor and production. In a world of increasing layers of fluff, unreality, and fictions, the incentive structures get increasingly distorted and abstracted from core functions and the real "gears,and wires" of what must get done.
Examples that fit the theme-
**It seems that the incentive for company management is increasingly to polish an image to would be investors, not even primarily about polishing to product itself. (Disatrous and extreme caricatures of this- SBF, Elizabeth Holmes).
**ESG seems to be another layer of fictional performance that becomes a driving metric that is untethered, distorts incentives, diverts attention and resources, becomes the barnacles (at best) and the cancer or virus (at worst)
**complex investment vehicles like credit default swaps
** ?endless string of investment hedges?
**constantly created and competing "narratives" some of which are cruel and cruel, and other grounded and real
**manufactured and exaggerated crises used to manipulate
**to numerous to mention "emperor has no clothes" moments exposing the cracks
So (trying to bring it back here, thanks for hanging in there) if passive investing is just another layer of separation and abstraction, it seems you are saying that it becomes another massive vulnerability. Is it an economic and financial manifestation of the larger trend? Can the complexity and abstraction ever be its strength or only its weakness?
We have two evolving "camps." One - more performance, more meta, more kayfabe, a dance that earns points but distracts from core missions and realities. The other that is tied to "financial fundamentals," the realities of physics, and human nature and biology.
Those who are still bound by these fundamental realities and talk sense to them sometimes seem to be shouting in the wilderness (though their voices are gaining traction). How do we reconcile these at all levels?
I understand your point about the increasingly disreality we live in/kayfabe all. In regards to passive I'm not quite sure it fits in with the other things you mentioned. Passive at 10% of the market is probably fine. It's just that we've never considered that at 50 or 60% of the market it's not fine. I think passive was more or less genuinely intended as a good thing, but now it's getting out of control.
The broader abstraction we now live in is a topic near and dear to my heart. This is no genius insight on my part to say that I think a lot of it has to do with the internet and the way we relate to each other through avatars and screens, instead of in person. I think that as we do this for years/decades on end it starts to engender a certain interaction style that we carry over into the real world too.
As too the kayfabe of society, the CDOs and derivatives and finalization of everything. That which cannot go on forever, won't. My basic framework for understanding this is that the Fed has one more ace up its sleeve: if shit gets really bad I think the Fed will buy stocks and that will patch up the markets for a few more years. After that though, in the next-next financial tragedy I think the Fed will be powerless and no matter how much they buy the system is going to unravel. I could be totally wrong, who knows, but that's the basic framework I use to try and understand an unknowable future.
The way I deal with this wacky, disconnected society is to stay as grounded as possible. Read books. Live in the physical world, take my dog for walks, have as many in person interactions as possible, and generally realize that this all won't last forever. If Neil Howe is correct than the 2050s could be a golden age! Only 27 years to go
Thanks for the reply. I will definitely send email to redeem my sticker.
The connection of passive investing seemed related, though I had not reality considered it before reading your piece this morning. My point is that the biggest funds/managers Blackrock, Vanguard have endorsed investing based on metrics that have become more independent of the primary focus of a given corporation and frequently counter to corporate/business goals, but using the resources of the company because of the "value" in the ESG virtue signalling performance points and validation. This boosts the company's perceived and virtual value and drives more investment, with no needed improvement in fundamentals, boosting the house of cards. More fictions. Less reality. More avatar. Less human.
I totally agree with you, it's possible to boost a company's profile with a bit of hand waving. We live in the age of narrative, we're in a bubble for narrative. The gulf between the "truth" of a thing and the thing itself is massive.
I live close to the ocean and prior to Covid we used to get heaps of Chinese tourists. I always hold them as a high example of a people disconnected from reality. These Chinese tourists were THE WORST at understanding the power of the water. They would wade into the waves clutching their smartphones and laughing, completely oblivious to reality. An entire family almost drowned once, another time I had to rescue someone who drifted 150 feet out on a body board and couldn't get in. They seem to live in a bubble. A microcosm for how we're all living right now.
This argument is flawed, and here are some reaaons why.
Say you buy an S&P 500 ETF. This is only "passive" if the rest of your portfolio replicates the composition of the global asset portfolio, so bonds, stocks, commodities, real estate etc weighted by market cap", so your s&p buy is matched by purchases in the correct quantity of everything else. If your portfolio is anything else, you are active - you have made a conscious decision to overweight something. So "passive" really means making asset allocation decisions.
Back to the s&p 500 etf. Ok, maybe it is an active allocation decision, but surely it is passive in security selection? Well... no. To join the s&p you need to be profitable and have a big-ish market cap. That rules out unprofitable co's, so keeps you insulated from the excesses of growth. You get kicked out if you lag peers (eg if your market cap is stagnant while everyone else is growing, eventually someone will enter the index at your expense) and if you crash enough you will be removed. Effectively, companies that lose money and lose the patience of shareholders get cut from the portfolio, companies that are profitable and large get added - without you doing anything. By contrast, buying the MSCI US ETF, which has no profitability criteria, gives you a different set of exposures. So a "passive" decision is actually very active.
I understand the arguments you're making and I think that perhaps I didn't do a good job articulating my argument. My scope is narrow. I understand that choosing which asset classes to allocate to is an active decision. I also realize that there are criterion for which securities get included in any given index fund.
My point is that once a security is in an index, so long as it remains in the index it's going to automatically receive inflows regardless of its fundamentals. Mike Green has estimated that in excess of 50% of all inflows are now passive, which means that every other dollar is being directed by a "dumb" index rather than an active manager selecting securities based on their inherit qualities.
Does this really matter though? Passive flows can increase equity valuations relative to other assets if flows are out of proportion. But passive never sets marginal price - almost all orders target the index price (either vwap or official close) so price thru the day is set by active investors. Pre-passive, you had good investors and bad investors. Passive causes funds to migrate from bad investors to price takers, so only good investors left to set prices (notice how bond funds), and the size of the good investor base gets smaller as the easy money from fleecing bad investors gets taken off the table.
The good news for active investors is ESG means a whole bunch of good investors are now forced to act like morons, and their idiocy is multiplied by passive ESG. So taking the opposite side of their trade will be a great source of alpha over the next decade or two, especially in Europe.
Even if passive is not setting the marginal price during daytime trading, it's still absorbing a massive number of shares which won't typically transact during moments of over/under valuation.
I think we might just have to agree to disagree. I was thinking about how to explain my argument better but I realized I would just end writing the same article again. So I guess we'll just wait and see what happens in the coming years.
One of your new subscribers here. Found you through The Free Press.
Almost feel I’m at AA. Hi my name is Pat and I’m a Passive Investor. So this being one of my first pieces to read on your Substack piqued my interest and caused a little concern. I have tried to learn about investing but it seemed like this huge enigma. So I just did the usual thing, put money in my 401K but only knew enough to be dangerous about which funds to put it in. Then came along a colleague with “The Little Book of Common Sense Investing” by Bogle (you know the guy who started the index fund fad or now should it be index fad funds?) Throw in reading the “Psychology of Money” whose author’s name escapes me and now I am all I with passive index funds.
I do like educating myself but with limited time I need short, simple information that is impactful for a small time investor (primarily for retirement but wouldn’t mind getting a better rate of return) who is willing to wade into medium risk investment (I’m mid 50’s).
Any possible way you could steer me toward sites to help with the above info in mind? I plan on checking out more of your posts and the gentleman you recommended in this one.
I’m not looking for you to manage my funds or set up tutorials for me but even if it’s “hey go this site and they have some good info for newbies” would be great.
Anyway enjoy your take on things with the bits of sarcasm through
PS don’t know the name of the beach but hope it was with the hike
Hey Pat,
I don't know that you need to feel concern. The thing with passive is that it might be bad for society as a whole, but it can still be a good way to make money. Provided that money keeps going into passive, it will continue to create a situation where indexes do well. Just look at today, for example. For months and months many smart investors have been talking about a market collapse. Those smart investors (generally speaking) have been going short or simply staying in cash, all the while people just staying in passive funds have done fine. SPX at 4k pretty much. That could change any moment of course, but it shows how passive certainly can be OK.
The book "Richer, Wiser, Happier" is fantastic, a strong recommendation from me. And this YouTube channel has loads of excellent content geared at people who are newer to markets
https://www.youtube.com/@TheInvestorsPodcastNetwork
Blockworks Macro on YouTube is also quite good
Glad you enjoy the sarcasm. A bit of humor is necessary to stay sane in this world.
PS - Psychology of Money was written by Morgan Housel
Thanks for the information.
Kelingking Beach in Bali
I think I found you from a Twitter link, but I'm not sure. I am always looking for legitimate insights and discussion on a range of topics and I really appreciate that thoughtful, smart, and talented people are sharing their thoughts and steering me to the network of similarly inclined people that they value.
I am a mostly passive investor who aspires to find and reward good companies with good ideas, but the time to evaluate and follow individual companies eludes me.
The abstraction and separation that you paint with passive investing reflects these same trends at more micro levels throughout human endeavor and production. In a world of increasing layers of fluff, unreality, and fictions, the incentive structures get increasingly distorted and abstracted from core functions and the real "gears,and wires" of what must get done.
Examples that fit the theme-
**It seems that the incentive for company management is increasingly to polish an image to would be investors, not even primarily about polishing to product itself. (Disatrous and extreme caricatures of this- SBF, Elizabeth Holmes).
**ESG seems to be another layer of fictional performance that becomes a driving metric that is untethered, distorts incentives, diverts attention and resources, becomes the barnacles (at best) and the cancer or virus (at worst)
**complex investment vehicles like credit default swaps
** ?endless string of investment hedges?
**constantly created and competing "narratives" some of which are cruel and cruel, and other grounded and real
**manufactured and exaggerated crises used to manipulate
**to numerous to mention "emperor has no clothes" moments exposing the cracks
So (trying to bring it back here, thanks for hanging in there) if passive investing is just another layer of separation and abstraction, it seems you are saying that it becomes another massive vulnerability. Is it an economic and financial manifestation of the larger trend? Can the complexity and abstraction ever be its strength or only its weakness?
We have two evolving "camps." One - more performance, more meta, more kayfabe, a dance that earns points but distracts from core missions and realities. The other that is tied to "financial fundamentals," the realities of physics, and human nature and biology.
Those who are still bound by these fundamental realities and talk sense to them sometimes seem to be shouting in the wilderness (though their voices are gaining traction). How do we reconcile these at all levels?
I'll stop now😁
I'll wait for response🤣🤣🤯🥸🤡
Kelingking it is... Send me an email chiefquant@unhedgedcapitalist.com and I'll get you hooked up with a free sticker.
I understand your point about the increasingly disreality we live in/kayfabe all. In regards to passive I'm not quite sure it fits in with the other things you mentioned. Passive at 10% of the market is probably fine. It's just that we've never considered that at 50 or 60% of the market it's not fine. I think passive was more or less genuinely intended as a good thing, but now it's getting out of control.
The broader abstraction we now live in is a topic near and dear to my heart. This is no genius insight on my part to say that I think a lot of it has to do with the internet and the way we relate to each other through avatars and screens, instead of in person. I think that as we do this for years/decades on end it starts to engender a certain interaction style that we carry over into the real world too.
As too the kayfabe of society, the CDOs and derivatives and finalization of everything. That which cannot go on forever, won't. My basic framework for understanding this is that the Fed has one more ace up its sleeve: if shit gets really bad I think the Fed will buy stocks and that will patch up the markets for a few more years. After that though, in the next-next financial tragedy I think the Fed will be powerless and no matter how much they buy the system is going to unravel. I could be totally wrong, who knows, but that's the basic framework I use to try and understand an unknowable future.
The way I deal with this wacky, disconnected society is to stay as grounded as possible. Read books. Live in the physical world, take my dog for walks, have as many in person interactions as possible, and generally realize that this all won't last forever. If Neil Howe is correct than the 2050s could be a golden age! Only 27 years to go
Thanks for the reply. I will definitely send email to redeem my sticker.
The connection of passive investing seemed related, though I had not reality considered it before reading your piece this morning. My point is that the biggest funds/managers Blackrock, Vanguard have endorsed investing based on metrics that have become more independent of the primary focus of a given corporation and frequently counter to corporate/business goals, but using the resources of the company because of the "value" in the ESG virtue signalling performance points and validation. This boosts the company's perceived and virtual value and drives more investment, with no needed improvement in fundamentals, boosting the house of cards. More fictions. Less reality. More avatar. Less human.
I totally agree with you, it's possible to boost a company's profile with a bit of hand waving. We live in the age of narrative, we're in a bubble for narrative. The gulf between the "truth" of a thing and the thing itself is massive.
I live close to the ocean and prior to Covid we used to get heaps of Chinese tourists. I always hold them as a high example of a people disconnected from reality. These Chinese tourists were THE WORST at understanding the power of the water. They would wade into the waves clutching their smartphones and laughing, completely oblivious to reality. An entire family almost drowned once, another time I had to rescue someone who drifted 150 feet out on a body board and couldn't get in. They seem to live in a bubble. A microcosm for how we're all living right now.
Lol
This argument is flawed, and here are some reaaons why.
Say you buy an S&P 500 ETF. This is only "passive" if the rest of your portfolio replicates the composition of the global asset portfolio, so bonds, stocks, commodities, real estate etc weighted by market cap", so your s&p buy is matched by purchases in the correct quantity of everything else. If your portfolio is anything else, you are active - you have made a conscious decision to overweight something. So "passive" really means making asset allocation decisions.
Back to the s&p 500 etf. Ok, maybe it is an active allocation decision, but surely it is passive in security selection? Well... no. To join the s&p you need to be profitable and have a big-ish market cap. That rules out unprofitable co's, so keeps you insulated from the excesses of growth. You get kicked out if you lag peers (eg if your market cap is stagnant while everyone else is growing, eventually someone will enter the index at your expense) and if you crash enough you will be removed. Effectively, companies that lose money and lose the patience of shareholders get cut from the portfolio, companies that are profitable and large get added - without you doing anything. By contrast, buying the MSCI US ETF, which has no profitability criteria, gives you a different set of exposures. So a "passive" decision is actually very active.
I understand the arguments you're making and I think that perhaps I didn't do a good job articulating my argument. My scope is narrow. I understand that choosing which asset classes to allocate to is an active decision. I also realize that there are criterion for which securities get included in any given index fund.
My point is that once a security is in an index, so long as it remains in the index it's going to automatically receive inflows regardless of its fundamentals. Mike Green has estimated that in excess of 50% of all inflows are now passive, which means that every other dollar is being directed by a "dumb" index rather than an active manager selecting securities based on their inherit qualities.
Does this really matter though? Passive flows can increase equity valuations relative to other assets if flows are out of proportion. But passive never sets marginal price - almost all orders target the index price (either vwap or official close) so price thru the day is set by active investors. Pre-passive, you had good investors and bad investors. Passive causes funds to migrate from bad investors to price takers, so only good investors left to set prices (notice how bond funds), and the size of the good investor base gets smaller as the easy money from fleecing bad investors gets taken off the table.
The good news for active investors is ESG means a whole bunch of good investors are now forced to act like morons, and their idiocy is multiplied by passive ESG. So taking the opposite side of their trade will be a great source of alpha over the next decade or two, especially in Europe.
Even if passive is not setting the marginal price during daytime trading, it's still absorbing a massive number of shares which won't typically transact during moments of over/under valuation.
I think we might just have to agree to disagree. I was thinking about how to explain my argument better but I realized I would just end writing the same article again. So I guess we'll just wait and see what happens in the coming years.