50 years of "A Random Walk Down Wall Street"

[NotSure]

50 Years Later, Burton Malkiel Hasn’t Changed His Views on Indexing

The author of the classic ‘A Random Walk Down Wall Street’ still believes the markets are hard for any individual to beat

.....WSJ: Let’s talk about the social cost of indexing. Indexing succeeds by free-riding on the costly research and price-finding activities of active investors. What if everybody did it? Would we even have a stock market? How would we allocate capital? Doesn’t indexing reward mediocrity and excellence equally?

DR. MALKIEL: We don’t have too much indexing; we have too much active management. I think the market could function fine with just 2% or 3% of investors being active and making sure that information was reflected properly in prices......

free link to WSJ article/interview

[Dod101]

50 Years Later, Burton Malkiel Hasn’t Changed His Views on Indexing

The author of the classic ‘A Random Walk Down Wall Street’ still believes the markets are hard for any individual to beat

.....WSJ: Let’s talk about the social cost of indexing. Indexing succeeds by free-riding on the costly research and price-finding activities of active investors. What if everybody did it? Would we even have a stock market? How would we allocate capital? Doesn’t indexing reward mediocrity and excellence equally?

DR. MALKIEL: We don’t have too much indexing; we have too much active management. I think the market could function fine with just 2% or 3% of investors being active and making sure that information was reflected properly in prices......

Even if that were true, there would surely be a problem of liquidity with many shares and so the prices could not and would not properly reflect all the available information. Index funds rely on an active market. I see indexing as a perfectly legal although somewhat selfish activity or rather, non activity.

Dod

[NotSure]

Even if that were true, there would surely be a problem of liquidity with many shares and so the prices could not and would not properly reflect all the available information. Index funds rely on an active market. I see indexing as a perfectly legal although somewhat selfish activity or rather, non activity.

Dod

I hoped that snip would generate some debate, so thanks for responding.

Prices are famously "set at the margins", so reflect the trading of typically a very low percentage of the available shares.

Legal? Yes, I believe you are correct - indexing is legal.

But selfish? Why so? Surely creaming a percentage while under-performing is selfish?

[Urbandreamer]

My post got lost in the ether, but basically I tend to agree with Dod.

I really doubt that a figure as low as 2-3% of market participants can move prices to reflect information. Indeed, I would argue that talking " 3% of investors" shows poor consideration of the question.

Consider a market of 100 investors, almost all (97%) randomly buying and selling. Three of them own a total of 90% of the market cap and are active traders. I would expect the effect of their actions to vastly move the price. Now consider the same situation, but those three investors own 0.1% of the market cap. Would the same be true? Indeed, would the information that those three knew be reflected in the price if they traded such small volumes?

As for "selfish", well it's not the word I would pick to avoid contention. However, the problem is known as the "free rider" problem, which is about a group benefiting from the activities of others without contributing themselves. This is often considered selfish.

[dealtn]

Consider a market of 100 investors, almost all (97%) randomly buying and selling. Three of them own a total of 90% of the market cap and are active traders. I would expect the effect of their actions to vastly move the price. Now consider the same situation, but those three investors own 0.1% of the market cap. Would the same be true? Indeed, would the information that those three knew be reflected in the price if they traded such small volumes?

You would need to define what you mean by "price". If nearly all the market passively indexed and rarely traded, with just 3 of the 100, owning just 0.1% of the market cap, determining the "price", then as long as you always had 1 of the 3 active on either side of the market then you have a stable, but illiquid, market with a regularly available price not moving in a particularly volatile manor. With 2 (or 1 or 3) on a single side of the market and none on the opposite then you can potentially have an illiquid and volatile unstable set of prices.

None of which matters if all the passives are truly passive and unconcerned.

If "price" is determined as having a meaning on where a passive deciding to exit (or enter) the market, in effect becoming an "active", then with just 3 of the 100 being price setters and only providing liquidity of around 0.1% of the market cap, then the "price" in this instance is potentially a big distance from the last observed price.

[NotSure]

.....As for "selfish", well it's not the word I would pick to avoid contention. However, the problem is known as the "free rider" problem, which is about a group benefiting from the activities of others without contributing themselves. This is often considered selfish.

Surely the active investors benefit from the liquidity and overall demand for shares that the advent of passive investing provides?

(Biased) Discussion here, FWLIW:

https://www.businessinsider.com/passive-investing-makes-markets-more-efficient-2016-5?r=US&IR=T

..Though perhaps the biggest and most controversial implication out of Livermore's analysis is that the increase in passive management makes markets more efficient.

The simple outline here is that if you allow unsophisticated investors to achieve the market return passively and efficiently — you can get the S&P 500 return for a fee of just 0.05% per year from Vanguard, for example — you make the average remaining active managers more sophisticated.

And with less sophisticated investors getting out of making decisions about their investments, the argument that follows is that the remaining investor is, on average, better.....

[Lootman]

As for "selfish", well it's not the word I would pick to avoid contention. However, the problem is known as the "free rider" problem, which is about a group benefiting from the activities of others without contributing themselves. This is often considered selfish.

I think "selfish" is completely the wrong word. Buying and holding an index fund is really a statement that you either think it is unlikely that you can beat the market, or that it would take so much effort that it is not really worth trying. As such it is an assertion of modesty, almost the opposite of selfishness.

It also can make sense when you consider that the long-term return from shares has been around 8% to 10% annually on average for the last century or so. That's a very easy return to get versus trying to get such a return from active trading, which comes with higher risk and costs.

And using index funds isn't that different from buying active funds. You are still delegating all the hard work of picking shares and managing a portfolio to someone else, for a fee. Nobody would call that selfish. Efficient, perhaps?

I suspect that many private investors do what I do, which is have a handful of index fund as the core of my portfolio, and then have some active bets around the edges where I feel I might be able to add some value, or else just for fun and giggles. It is not necessarily an either/or.

[Dod101]

As for "selfish", well it's not the word I would pick to avoid contention. However, the problem is known as the "free rider" problem, which is about a group benefiting from the activities of others without contributing themselves. This is often considered selfish.

I think "selfish" is completely the wrong word. Buying and holding an index fund is really a statement that you either think it is unlikely that you can beat the market, or that it would take so much effort that it is not really worth trying. As such it is an assertion of modesty, almost the opposite of selfishness.

It also can make sense when you consider that the long-term return from shares has been around 8% to 10% annually on average for the last century or so. That's a very easy return to get versus trying to get such a return from active trading, which comes with higher risk and costs.

And using index funds isn't that different from buying active funds. You are still delegating all the hard work of picking shares and managing a portfolio to someone else, for a fee. Nobody would call that selfish. Efficient, perhaps?

I suspect that many private investors do what I do, which is have a handful of index fund as the core of my portfolio, and then have some active bets around the edges where I feel I might be able to add some value, or else just for fun and giggles. It is not necessarily an either/or.

I used the word 'selfish' because passive investors are relying on the active ones to make an index in the first place. After all if everyone was passive, nothing would happen and there would be no market, no buying, no selling nothing.

Dod

[Urbandreamer]

I suspect that many private investors do what I do, which is have a handful of index fund as the core of my portfolio, and then have some active bets around the edges where I feel I might be able to add some value, or else just for fun and giggles. It is not necessarily an either/or.

Indeed so. While we have a good mix of passive and active investors, the active ones can play a part in the "price discovery" mechanism.

My dispute isn't with anyone on TLF, or indeed anyone who is likely to be reading this post. It's with Dr Malkiel's words.

As I said, "selfish" is not a word that I would choose.

What about allocation of capital? If we have no active investors, then new companies or start-up's can't exist. New capital can't be raised by existing companies. No right's issues open offers or floatation's.

Price is just the means by which a company, and its work is valued. Hence, some companies can have high prices, even burning capital, as investors believe that profits will arrive. Wasn't Amazon known as "the company of no returns"?

As for "And with less sophisticated investors getting out of making decisions about their investments, the argument that follows is that the remaining investor is, on average, better....", that's not the argument made by Dr Malkiel either in his book (yes I read it) or in the article. Indeed, he argues that both isn't true and can't be true.

Ps, I'm not opposed to passive investment. Indeed, 25% of my investments are in passives. I simply question the belief that the market can function without active investors or with as few as suggested.

[NotSure]

I used the word 'selfish' because passive investors are relying on the active ones to make an index in the first place. After all if everyone was passive, nothing would happen and there would be no market, no buying, no selling nothing.

Dod

I think that is a little "reductio ad absurdum"?

Surely, well before we got anywhere near there, some active investors would be making out like bandits?

[NotSure]

.....As for "And with less sophisticated investors getting out of making decisions about their investments, the argument that follows is that the remaining investor is, on average, better....", that's not the argument made by Dr Malkiel either in his book (yes I read it) or in the article. Indeed, he argues that both isn't true and can't be true....

I have not read his book, but in the interview it is a bit unclear to me what he says/means. He stated 3-4% of market participants was necessary for correct functioning of markets. Considering just funds/ITs I suspect the actual number is far less than that already. Funds can manage £Bs with just a handful of active investors (100s or 1000s at most) whereas millions participate passively via, for example Vanguard.

[Urbandreamer]

I have not read his book, but in the interview it is a bit unclear to me what he says/means. He stated 3-4% of market participants was necessary for correct functioning of markets. Considering just funds/ITs I suspect the actual number is far less than that already. Funds can manage £Bs with just a handful of active investors (100s or 1000s at most) whereas millions participate passively via, for example Vanguard.

Then we have the complexity that, for example, Vanguard Lifestrategy, is actually an active fund. Its remit is not to outperform the market and many consider it an index tracker, but it is actually an active fund.

https://www.vanguardinvestor.co.uk/inve ... s/overview

To be honest, having read his book, I would be dubious of his arguments. He bases a lot on how similar a record of coin tosses is to a graph of share prices. In the book, he argues the impossibility of benefiting from information, as such information is widely known and reflected in prices.

Were his argument a simple one that passive investment works well most of the time I would have no issue.

The argument that I got from his book is that there is no benefit from knowing anything about what you invest in. While it may be possible to "buy the market" without consideration of how individual constituents may perform in the future. It is not true, if buying shares in individual companies. Indeed, companies whose future looks very gloomy may have a share price. The market is not as efficient as theorized.

Ps, I should say that I haven't read the book in decades.

[tjh290633]

in the interview it is a bit unclear to me what he says/means. He stated 3-4% of market participants was necessary for correct functioning of markets. Considering just funds/ITs I suspect the actual number is far less than that already. Funds can manage £Bs with just a handful of active investors (100s or 1000s at most) whereas millions participate passively via, for example Vanguard.

Does anyone have a reliable figure about the percentage of the stock market held by passive funds? That might shed light on the problem. One assumes that most active investors only trade a small proportion of their portfolio. Looking at my own records, I see that in the last few years my transactions were:

Tax year   % YE Value
FY08-09        47.35%
FY09-10        36.35%
FY10-11        33.74%
FY11-12        12.07%
FY12-13         5.34%
FY13-14        19.30%
FY14-15         5.53%
FY15-16        15.20%
FY16-17        22.53%
FY17-18         9.46%
FY18-19         7.18%
FY19-20        19.87%
FY20-21        17.89%
FY21-22         7.13%

The years around 2008-10 were obviously traumatic, but I wonder how this compares with an active fund?

TJH

[OhNoNotimAgain]

in the interview it is a bit unclear to me what he says/means. He stated 3-4% of market participants was necessary for correct functioning of markets. Considering just funds/ITs I suspect the actual number is far less than that already. Funds can manage £Bs with just a handful of active investors (100s or 1000s at most) whereas millions participate passively via, for example Vanguard.

Does anyone have a reliable figure about the percentage of the stock market held by passive funds? That might shed light on the problem. One assumes that most active investors only trade a small proportion of their portfolio. Looking at my own records, I see that in the last few years my transactions were:

Tax year   % YE Value
FY08-09        47.35%
FY09-10        36.35%
FY10-11        33.74%
FY11-12        12.07%
FY12-13         5.34%
FY13-14        19.30%
FY14-15         5.53%
FY15-16        15.20%
FY16-17        22.53%
FY17-18         9.46%
FY18-19         7.18%
FY19-20        19.87%
FY20-21        17.89%
FY21-22         7.13%

The years around 2008-10 were obviously traumatic, but I wonder how this compares with an active fund?

TJH

I am surprised your turnover was so high Terry. The only data I know of is for an index fund whose PTR was 1 or 2%.

[GeoffF100]

Does anyone have a reliable figure about the percentage of the stock market held by passive funds?

It seems to be about half in the US:

https://www.cnbc.com/2019/03/19/passive ... arket.html

It is not clear how reliable that number is, but it is frequently repeated. If half the market is passively invested in the index, it does not trade (except for new issues etc). The other half of the market fixes prices and provides liquidity. That is not a problem. There is certainly a lot of trading and liquidity in the US market.

[MDW1954]

Just to say, I think that it's a brilliant book. Having been put off by the title for years, I finally succumbed in a bookshop in Hong Kong.

Many things made that trip memorable. But one of them is undoubtedly my delight in discovering and devouring that book.

MDW1954

[tjh290633]

in the interview it is a bit unclear to me what he says/means. He stated 3-4% of market participants was necessary for correct functioning of markets. Considering just funds/ITs I suspect the actual number is far less than that already. Funds can manage £Bs with just a handful of active investors (100s or 1000s at most) whereas millions participate passively via, for example Vanguard.

Does anyone have a reliable figure about the percentage of the stock market held by passive funds? That might shed light on the problem. One assumes that most active investors only trade a small proportion of their portfolio. Looking at my own records, I see that in the last few years my transactions were:

Tax year   % YE Value
FY08-09        47.35%
FY09-10        36.35%
FY10-11        33.74%
FY11-12        12.07%
FY12-13         5.34%
FY13-14        19.30%
FY14-15         5.53%
FY15-16        15.20%
FY16-17        22.53%
FY17-18         9.46%
FY18-19         7.18%
FY19-20        19.87%
FY20-21        17.89%
FY21-22         7.13%

The years around 2008-10 were obviously traumatic, but I wonder how this compares with an active fund?

TJH

I am surprised your turnover was so high Terry. The only data I know of is for an index fund whose PTR was 1 or 2%.

There are usually two reasons for a trade - trimming a holding which has become overweight and reinvesting accumulated cash. However there was a lot of portfolio adjustment after 2008, when a lot of companies stopped paying dividends and were sold. There has also been a number of take-overs, which lead to a total disposal and the purchase of one or more substitutes.

With dividend yield up to 5%, that alone accounts for 5% transactions. If I trim a share by 25% and that share is 4% of the portfolio, then the sale and reinvestment accounts for a further 2% of the portfolio. Likewise a takeover might account for 8% with the reinvestment.

It's not hard to get the transaction level to a high level.

TJH

[Urbandreamer]

Just to say, I think that it's a brilliant book. Having been put off by the title for years, I finally succumbed in a bookshop in Hong Kong.

Many things made that trip memorable. But one of them is undoubtedly my delight in discovering and devouring that book.

MDW1954

As I said, I read it some time ago. My copy dates back to the 90's.
At the time I thought that the ideas were brilliant. However I have since changed my mind.

I DO recommend that people read it themselves and make up their own minds as to it's value.

As a "book" it is brilliant, but then so is "The Zurich Axioms", yet you can't get two more different ideas.

PS, I still maintain that price discovery suffers as the number deciding what they will pay or sell for reduces. Too low, as in 3% rather than 50%, and I seriously question if it can function. Can a market BE efficient, if so few are choosing what they will buy or sell for? How low can we go? Can it be as low as 1% or even 1 buyer/seller who chooses? Hyperbole I know, but I really don't see it as too much of an extension from the suggested 2-3%.

[NotSure]

Then we have the complexity that, for example, Vanguard Lifestrategy, is actually an active fund. Its remit is not to outperform the market and many consider it an index tracker, but it is actually an active fund......

Indeed it is, but all it's investments are trackers. But anyway, I was referring to Vanguard trackers which account for millions are market participants. So it is active in the same why I am - I actively decide a) to buy equities rather than cash or property say, and b) which trackers I buy and how much of each.

.....To be honest, having read his book, I would be dubious of his arguments. He bases a lot on how similar a record of coin tosses is to a graph of share prices. In the book, he argues the impossibility of benefiting from information, as such information is widely known and reflected in prices....

He does sound like a bit of a fundamentalist (but he does have a new edition of his book to sell).

Disclosure: I am mainly passive, but an evolving mixture of indexed funds, and Lootmanesque, I like to play being active at the edges, especially in ISA. In my company pension, I am 90% mix of indexed (though this includes mixed asset funds). But I like to set and forget those no more than once a year (i.e. it is inactively managed, so may as well be passive IMHO). This year, I divided the active 10% in pension equally between 2 funds (i.e. 5% each). One is now at 6% the other now 4%. So the random walk theory seems to hold for just N = 2

But i still disagree regarding the selfish bit. Aren't all investors pretty much equally selfish? Finding a bargain, over looked company and not telling the world about until after you have purchased could be considered selfish (and telling the world afterwards certainly is )

[MDW1954]

Just to say, I think that it's a brilliant book. Having been put off by the title for years, I finally succumbed in a bookshop in Hong Kong.

Many things made that trip memorable. But one of them is undoubtedly my delight in discovering and devouring that book.

MDW1954

As I said, I read it some time ago. My copy dates back to the 90's.
At the time I thought that the ideas were brilliant. However I have since changed my mind.

I DO recommend that people read it themselves and make up their own minds as to its value.

Years later, I interviewed Malkiel, and produced two or three TMF articles (for the pre-2012 incarnation of TMF). I'll see if I can find them.

In any case, we may be talking at cross-purposes. The book is "brilliant" because it builds the case for saying "this is why you should invest for your future, and here's an easy way to do it."

Saying it's the best way is another matter. And the target audience for the book might not have been able to execute the "best" way, anyway.

Anyone can buy an index tracker.

MDW1954