Comment by Arn_Thor
6 hours ago
> 7. Index fund managers are not incentivized to exclude a SpaceX from their indexes. (?)
Correction: index funds don't have a choice. They must follow the index, and so must buy the stock.
side effect: they'll have to sell other stocks, pushing their prices and weighting in market cap weighted indexes down.
> Passive investors are unable to rapidly respond to these types of changes because liquidating portfolios will incur capital gains taxes. (?)
For some active investors, yes. For passive investors (say you through your employer's pension fund), the tax isn't the problem. It's that the market has such a short time to adjust the price of these companies before indexes are forced to include them--and so might buy them at wildly inflated prices. Then, not too long after, the early investors can sell at still-high prices as soon as their lockup periods end. It's a massive transfer of wealth from pension funds and index investors to the early investors in those companies.
> Correction: index funds don't have a choice. They must follow the index, and so must buy the stock.
Maybe, most indexes do not have to follow the index. they just need to match the returns. An index fund manager has choice of what stocks to buy. However an index fund doesn't have enough managers to make many choices and so they normally buy just what is in the index. However all index fund managers know they are large enough that if they change their holdings "instantly" when the index it self changes the market will collapse and so the fund will under perform. Thus index fund managers are always trying to figure out what the index will do so they can start buying/selling stocks in smaller amounts before the change happens.
How each fund handles this is up to the managers. (and "total market" funds have less ability and need to do this)
The whole point of index funds is that you don't have to pay management fees to managers. It's very expensive to hire a team of people to analyze the entire stock market in detail and chose the best 500 companies, and historically people who did that on average didn't beat the S&P500.
Just look up the performance of Mutual Funds vs S&P500.
That is the point, and index funds pay many less managers. However they all have a few managers to handle the various paperwork needed and those managers do make some decisions. They have much less influence vs a traditional funds, but it is slightly above zero.
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So are they incentivized to allow an obvious grift and let the index have middling returns so they can skim the difference?
but any upside to second guessing the index gets allocated to the management, right? just like any downside, so its kind of immaterial for the end users, they're effectively bought into to SpaceX anyways
They are judged by how close to the index their returns are. If there a significant deviation either way they are judged harshly. Each fund is different, but they typical thing they will do is buy a competitor of some company in the index once in a while.
Typically managers pay is such that they don't get awards for guessing correctly, so they won't get any upside from a correct second guess, and they will see downsides from incorrect guesses.
Also unlike traditional funds, there are not enough managers to follow every company, so they can't pick stocks that will win just because they don't have enough to time research the stock. When they pick a stock they are just looking at the high level will this company perform like the other peers in the industry long term.
But surely the managers of those pension funds can see this happening, and will not likely take on the risk of shares that are that young, no? The index funds hands are tied, i agree, but passive retirement funds are largely managed by people who are motivated for them to succeed. If this were not the case, then pension funds could have been looted long ago...
Pension funds that are actively tweaking the mix of stocks they hold likely might decide to play it safe.
On the other hand, do you want to be the one who says, "As a rule we follow the index, but this time we decided to break our own rule, and as a result we lost X% of returns"?
Better wrong with everybody else than wrong on my own.
The reason pension funds include index funds in their mix of investments is because those funds have two features that are exactly what pension funds are aiming for: (1) broad diversification, and (2) conservative inclusion rules that avoid undue exposure to highly volatile firms.
Changing one of those features undermines the reasons for including the index. Doing it specifically for the purpose of including a firm where large pension funds have also been extraordinarily critical of the governance structure as a particular source of risk [0] even moreso.
[0] https://www.reuters.com/legal/government/new-york-california...
>Correction: index funds don't have a choice. They must follow the index, and so must buy the stock.
Right, if they've advertised as an S&P 500 index fund, they have to robotically follow the S&P 500, stupid inclusions and all. Changing that strategy would require ... a lengthy process involving input from shareholders.
However, someone can still start e.g. a "classic S&P 500" fund that follows the old rules for inclusion, and I suspect we'll see that in response to these recent decision.
Mmmm legalized theft: the new Tech Industry!