Caught this story this morning on Bloomberg's Odd Lots podcast[1], it's a great story. The thread that stands out most to me (and to the hosts) is that here's a person who looks at an 840-page government report, reads it in-depth, and creates an industry. That's a feel-good outcome, of hard work others aren't willing to do.
In a coincidence, perhaps, Planet Money's latest episode[2] dealt with Warren Buffet's bet on an ETF over hedge funds.
To be clear, the Warren Buffet bet was about index funds. Not all ETFs track index funds, and even the ones that do aren't necessary. You can just buy into the funds directly.
ETFs are just investment funds you can buy and sell in the stock market, with their own symbol and everything just like any other stocks.
Index (passive) funds track an index, instead of trying to outperform the market.
You can have passive funds that are not ETFs (do not appear as a symbol in the stock market, have to go through a bank or whatever to buy shares), and active funds that are ETFs (actively managed).
Presumably any ETF is tracking something, that you could define to be an "index" in a degenerate sense (even if it's the "companies Buffet thinks are undervalued index", or the "solid gold bars index"). Or is there a technical definition of index?
If I understand correctly, ETF and index fund are orthogonal terms. An ETF is traded on the stock market -- in contrast to a mutual fund which you have to buy through other channels.
An index fund tracks an index rather than being actively managed.
I don't know about VSGAX specifically, but it could be both an ETF and an index fund.
That's not true if you sell stock to maintain a certain equity to debt ratio. If you use leverage in the S&P 500 then you have much a faster growth rate, so in the long term it's still better.
Clearly you cannot do math. It all depends on market timing, and if you get that wrong you will go broke as quick as your leverage. If you can get that right, well you would not be posting here, you would own here....
There's a funny story I read a while back about this play. If you did this for long enough eventually you'd be the biggest company in the S&P 500 (technically maybe not, but in practice very much so!).
he built index funds just like before. he was just the first one to afford enough lawyers to launch a product that would be shut down by regulators because of 800 page conflicting regulations
Putting aside the flamebait of your comment, you must not have read the story. The government report was following the massive crash in 1988 and was essentially an autopsy of what happened. One little section fantasized that perhaps a basket of funds might have helped avoid the events leading up to the crash. No regulations, no red-tape, just a postmortem accounting of the crash and a possible proscription.
Did you read TFA? Someone did an in-depth study of a market incident, noted a gap in the market, someone else filled the gap and made a successful product. They both presumably view it as a desirable outcome. Your aversion to it as a (hardly heavy-handed) government intervention is not really their problem.
If the same guy had written a white paper and tweetstorm while employed as a VC or investment banker or economics professor it wouldn't exactly be the difference between liberty and slavery.
One big factor in the success of these ETFs is automation (aka HFT). You don't get SPY quoted in size at a penny spread without the massive investments in research and technology on the part of the ETF market makers.
The value of the ETFs closely follow the value of the indices or securities that the fund was designed to track. It is therefore very important for the two securities to be as synchronized as possible, which is where (some forms of) HFT comes in.
emcq is sort-of right, that for buy-and-hold investors a small tracking error is OK, as long as it does not accumulate over time.
But once you have the nice deposit/receipt system set up to incentivise people to trade the tracking error away with arbitrage, you get a smaller and smaller tracking error for free.
It is not obvious to me that the error would not accumulate. In fact, the opposite becomes somewhat clear if one looks at similar products that differ mainly in their lack of an arbitrage mechanism.
Aside: The article mentions the "portfolio insurance" strategy and "program trading" as causes of the October 1987 crash. Basically, the portfolio insurance strategy was common in the 1980's and was typically implemented through program trading.
Portfolio insurance basically replicates a put option against some index, typically using index futures. The idea is that if you can't buy a put option against something, you can replicate it by creating a short position but you have adjust the size of the short position as the underlying price changes, aka a "dynamic hedge". Since the delta of a put option decreases as the price of the underlying falls, you have to short more (up to a point) when the price falls. There's nothing inherently wrong with this strategy.
However, if everyone (or a substantial portion of the market) is following this same strategy, it could be bad. This paper [1] reviews the commonly-point-to reasons for the October 1987 crash, and talks about program trading and the portfolio insurance strategy as potential causes, but also indicates that there were other issues at play. This other paper [2] looks at what happens when everyone, or substantially everyone, is following the same or similar strategy when it comes to portfolio management and/or trading strategies.
If one likes conspiracy theories one could argue it was deliberate move to concentrate voting rights. Considering that 4 entities now control voting rights in majority of public US companies one could argue it worked.
I'm still skeptical of ETFs as I see them as being a derivative product - not trading the original shares, but tickets representing them. So I see the same dangers/risks with them as with mortgage-backed securities.
While I may be acting like an old fuddy-duddy, there is this:
>Of the 1,278 securities halted for trading, 80 percent involved ETFs, according to the SEC.
The difference is in the leverage. MBS blew up the economy because the banks betting on them were very highly leveraged and had more obligations than they could realistically pay out. An ETF is more akin to a share of stock in a company. The worst it can do is go to 0 and lose all value. It won't result in a 30x loss like a derivative would.
That depends on the type of ETF. As far as I understand a "Physical ETF" does hold the securities of the index it follows. In contrast, "Synthetic ETFs" track an index using
swaps and collateral.
I assume they disclose what type they are? Also, any idea what the ratio of synthetic ETFs to physical ETFs may be? If it's low, it's not a potential market problem.
You own the real thing for example with SPY, which you can redeem to own the individual stocks. This of course cannot be true for all ETF-s, only the index funds.
Not. $3T is the value of the assets held by the funds, the value of the industry is the expense fees. Its probably lower than that, if ETFs didn't exist some portion of that $3T would instead be held in mutual funds.
In a coincidence, perhaps, Planet Money's latest episode[2] dealt with Warren Buffet's bet on an ETF over hedge funds.
1: http://www.bloomberg.com/news/articles/2016-03-07/odd-lots-h...
2: http://www.npr.org/sections/money/2016/03/04/469247400/episo...