S.P.R.E.A.D. #11 | 08 FEB 2020 | INVESTING w/ Steven

Topics Not Covered:

POTENTIAL PROBLEMS WITH INDEX FUNDS

Vanguard, and indexing in general has gotten so popular that academics and others are worried about the effect it has the market. Equity held by indexed funds has recently (~2019) surpassed equity held by mutual funds and individuals. What will happen when most of stock ownership is in the hands of people who simply don’t care about the stock market?

So far, three concerns come to light – 1) The effect on the valuation of shares, 2) inflating the value of certain companies, and 3) concerns about corporate governance. 

1) The free market allows for proper valuation of businesses by the trading of shares. One central theory of economics is that the more people that are buying and selling a product, the more accurate pricing is in determining the value of that product. When very few people trade the product, it’s harder to determine how valuable it is. When we can’t properly value businesses, investors will find it harder to determine general investing strategy, and potential chaos (though I have yet to read on what that chaos would entail).  

The concern is that the weakening of price discovery will disrupt the market. The rebuttal from index investors is that the effect of indexing on price discovery would only be significant if the trading stock by index funds make up a large part of daily trading activity. Vanguard said its 2017 numbers showed that indexed funds only accounted for 1-5% of all trading volume, which would mean an almost negligible effect on price. Secondly, the Financial Times wrote that the popularity of indexing has and will continue to cause a number of mutual and hedge funds to close up shop, making the market more efficient. Similarly the movement of active investors to passive investing contributes to the reduction of “noise (i.e. inexperienced traders)” in the market, allowing for a market in which only people that know what they’re doing does things properly. 

Indexes track the entire market, but what if there are only indexers left in the market? Some experts say that before you get to an ‘inefficient market’, one where a vast majority (80%+?) of the market were held by index funds, you’d have to get rid of a lot of people who are now involved in active trading. The number is so large, that it’s hard to imagine it happening. 

Even besides that, it’s human nature that a portion of the population desires and enjoys the high risk and high reward activity, along with the idea of beating the market. Indeed, if a large majority of the market were indexed, this would mean that the market is more predictable, and easier to get an edge on. It would seem that the incentive will always remain high enough to attract a certain amount of people predisposed to the excitement of active trading. 

2) Because index funds simply buy shares in the biggest companies, a lot of shares are being bought as more people put their money in index funds, potentially artificially inflating its value. When the price of the shares go up for no substantive reason, and simply because it is being bought, it results in overvaluation, which, over time, results in a ‘bubble’ that, once discovered, results in massive sell offs and great losses. 

3)Finally, because ownership of stock means ownership in the company, index funds holding big sections of companies means they also hold decision making power. Today, Vanguard and Blackrock dominate the market, concentrating power in these three companies. Vanguard’s legacy is more than virtuous, and Blackrock has been on the right side of certain social and environmental issues, saying they will divest or influence certain companies to act in the public good. But despite the so far good behavior of these companies in a powerful position, we know that a benevolent king does not mean that monarchy is preferred. The concern is that when the good leaders go, some less virtuous people will abuse their power to bend the market to their will. Thus the concern of corporate governance.

Abstract/ Unfinished Notes on markets in a capitalist system

The market, in a capitalist systems, allows for Efficient distribution of resources, creation of capital for businesses to grow, increase of productivity and innovation, and liquidity of capital for most everyone involved.

In starting a business, consider the value you would add to the world, and then make the numbers work.

All normies in finance and wealth seek tricks and tips to maximize individual returns. But john bogle’s perspective seeks to provide more objective and expansive commentary on the system in general – the greater patterns and general movements, and prescriptions to move in one direction or another

Similarly, it is the philosopher leader’s job to seek the higher view and grapple with more substantive questions…

The stock market, indeed, our whole economy is built on measures of trust and security. People borrow money because they trust that they can make things and sell things. People lend money because they trust in others to make a marketable product. We build a society not on resources on the ground, but with the goods of human social interaction and institutions. Once faith in that is lost, people stop enterprising. As more and more people have more faith in the system and its security, people will embark on projects. Does faith in the markets and its “true mission” result in invest in long term investments, soundness and stability, and a continuing cycle of prosperity? 

What is the purpose of the free market? Historically, it was for goods to be distributed so that both actors ‘won’ or made a profit. On the large scale, it was for a group to interact with their environment with their wits and do good for themselves. What is the role of those who weren’t smart enough to lead in this innovative and productive activity? In comes compassion? At any rate, the pressure for survival was on – life was rough, and productivity meant security. As things went on and technology increased, life was secured. In the current age, what does free market capitalism do for us? Does it simply perpetuate the need for some companies to rise to the top? To what end, given that the technological and logistical capability to supply that initial need has theoretically possible for decades. It allows people to innovate, deliver, and be rewarded for their efforts. It does not allow (make room for) charity or public good. 

So where is it headed? Those at the bottom will continue to suffer without organized charity or structural improvement, while those with good starting positions or exceptional products will continue to innovate. 

Profitability of firms mean that they are providing a needed service or product as well a significant social benefits. In the big picture, it means that a group of people are being generally productive, though this says nothing for the ‘losers’ as the economy evolves and the importance of the need for productivity fluctuates based on the society’s philosophical ruminations (or lack thereof). 

What is the role of profit? How did this change over time and history? From stone age to now and the future. 

We are always on a spectrum and a timeline (Hegel), we have to know our place in it and figure out how to act in accordance to reason and the future. 

P 46 – people are choosing short term money instead of fulfilling their roles and responsibilities as stock owners in demanding the [long term] interests of shareholders. People use stock as instruments of speculation, but don’t engage with the market in a more fundamental, wise way. Stock is decoupled from real market and true capitalism. Ask people why they buy stock and their answer is to make money – completely wrong! It should be to promote the growth of businesses… Is our current society set up for this to happen? Is the role of the market articulate, taught, and are our institutions and structure capable of making such things evident and actionable? Nope.

Bigger idea about people having roles and duties and how human greed or want is influenced by culture or society and notions of how to address these undesired behaviors. 

The class of money managers having interests misaligned from the stockholders or pension beneficiaries. One must consider the utility of active traders and the vital role they play in analyzing stock and trading, thereby setting accurate prices. There is a balance to be had. One should find out what that should be.

Starting points for prescriptions – regulation and legislative solutions – p 59

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Beginning this morning with bogles last autobiographical memoir. Forward has this diagram: if u began with initial $500 in 1977 and only added $100 more per month until 2017 the value of your portfolio would have grown from $500 to $762,690, with a total contribution of $48,400

Study the value of the portfolio carefully though, and you’ll see a good amount of volatility, with yearly changes anywhere from +$140k to – $132k. But that doesn’t change the long term growth of markets as a whole

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That a scary number of people have no retirement savings.

https://s3.amazonaws.com/cfsi-innovation-files-2018/wp-content/uploads/2018/11/20213012/Pulse-2018-Baseline-Survey-Results-11-16.18.pdf

42% of all respondents (~5k) said they have no retirement savings). 

https://www.bloomberg.com/news/articles/2019-03-26/almost-half-of-older-americans-have-zero-in-retirement-savings

Government Accountability Office – 2016 – 48% of 55+ have no investment retirement plan