There is another part to the passive story that I witnessed when I used to sit on my former employer's Deferred Comp committee for many years, before retiring. We always hired experts to give us advice and our plan's offerings changed over time from all actively managed funds when I started working there in the early 80s to slowly incorporating more passive funds in this century after the dot com bust, as passive started to gain traction. Then there was a big change a year or two after the GFC. I remember it had to do with some sort of change in ERISA that resulted in our expert advising to start offering target date funds, more low cost passive and also reduce the overall number of choices we had previously offered, which ended up as reducing actively managed funds with higher costs (but we kept a few, particularly in the bond funds, to keep old timers like me happy). If I recall correctly, this had something to due with changes in how the plan sponsor's fiduciary duties were defined by the Labor Department in new regulations. One thing that struck me was when our expert was asked why we should do these things, his reply was that it was what the majority of other plans were doing and we were less likely to get sued for breach of fiduciary responsibility, if we followed what the majority of other firms were adopting as "best practices". In other words, just follow the crowd and you are less likely to get sued.
You would laugh if you saw the investment vehicles offered in my employer 401k lol. I’ve been thinking about it for months and it’s pretty frustrating.
Regarding active bond funds outperforming "passive" , you say 65% of active funds beat the index, can you translate that to excess yield gained? In terms of the 65% of funds and then the relative performance of the entire group. Just wondering.
From “believing in science” meaning don’t question the authorities, to believing in “global warming” meaning blindly accepting whole slew of ever-changing things, to “believing in passive” meaning don’t bother looking at returns, simply trust all your money to the biggies at Vanguard and Blackrock.
Could you expand on the effects of passive investing on corporate and treasury bonds separately? I understand how corporate bonds can be distorted, but can treasuries also?
So the epic bond meltdown of 2022 only allowed active to catch up and exceed passive over the past five years? I guess when you consider AGG lost only -13% and not TLT's -31% you can see that being able to hedge, as active is and passive is not, would only close the gap of five years and not more. Will be interesting to see what the next five years holds. Even if "passive" outperforms active by the historical margin going forward it will take some years to erase the 2022 implosion from the relative performance tape. I suspect it will though.
Comparing bond indices to equity indices isn't completely fair. Theoretically, the large market cap of AAPL means market participants expect them to be able to return more value to shareholders than any other equity. A market cap weighted equity index will therefore have a large allocation to AAPL.
A large allocation in a market cap weighted bond index just means that company has a lot of debt. It doesn't speak to investor's expectations of the credit worthiness or likelihood of repayment. In fact, perhaps the opposite in some cases.
Would Enron have been the largest holding in passive high yield funds on the way down purely because the amount of downgraded debt represented such a large share of the high yield market at the time?
Also worth considering, the bond market has many more non-economic actors. Central banks do things for lots of reasons, and it isn't about making the most money on their balance sheet. Ask Harley if he thinks the TIPS market reflects reality or if fed policy distorts those markets.
Great work, Mike! Isn't it that bond funds have difficulties to capture gains from duration when rates decline (because they need to hold their prospected duration, e.g. 7-10 years, constant)? I.e. the (first) Big Short with a twenty year Zero Coupon Bonds in 1982 should have vastly outperformed any (not leveraged) bond fund, no? And by discretion, active managers (when not bound to an average duration) would also outperform if they would not average down with falling yields. Actually, isn't that the magic for bond traders?
You are certainly not shouting into the void Mr. Green. Firstly, I asked chatGPT to write you a thank you note, and it was far too verbose and full of silly hyperbole. After several attempts to arrive at brevity and substance, I came to the conclusion that chatGPT is a bit of a brown-noser. So I'll just have to give my own.
Thank you sir. Your willingness to sacrifice your time and effort in the pursuit of the greater good has extracted from me (and many others I imagine) respect, attention, and further devotion of my time and effort to finding an actionable course that aligns with your commitment. I understand this influence cannot currently be monetized by you, but please know you have positively impacted both my perspective, and my behavior. I routinely "name-drop" you (and a few others) when finding myself in conversations touching on topics you have engaged in. So perhaps what you have not extracted in dollars (or pick your currency... perhaps bitcoin... sorry, couldn't help myself there) , you have certainly extracted in influence. I see your work as the epitome of what the successful capitalist ideally would be called to as their public service. Thank you for your service.
As for your potential subscription pricing, I recommend in the strongest terms the most affordable pricing you can sleep with at night. I believe our society NEEDS the sort of ideas and perspective you share, which of course requires the least obstruction (such as paywalls) of dissemination possible for maximum effect.
Michael , I bought FIG after your recent article, but have yet to figure out how best construct a retirement portfolio in this crazy upside financial world using Simplify.
Passive is anything but passive indeed. It was truly devious of them to use that term to name their so-called new ideology at the time. They had to know that passivity, as defined by Bill Sharpe (thanks for referring back to the wise words of the master of the loser's game), was never going to actually be possible or certainly not at the promulgated low cost. There is nothing passive about investing, no matter how you look at it or approach it. I look forward to la suite!
Well done Mr. Green. "Indexing" or "Passive Investment Management" has been sold as the free lunch of investing ever since "Portfolio Selection" by Harry Markowitz in The Journal of Finance, Vol. 7, No. 1. (Mar., 1952), pp. 77-91
While Harry's paper did illustrate a nice theoretical relationship between the number of securities held and unique risk of those securities, the sales force that extrapolated that relationship to epsilon were the hucksters. We now see the tail routinely wag the dog in market volatility, all the while feeling smug and superior in our indexing and making the index sponsors the new King Midas class.
Agreed. And it’s both sad and amusing to realize that the false narrative that John Bogel sold to the public spawned some copy cats.
Perhaps the most egregious might be Robinhood, who is selling their image of being on the side of the little guy, while taking huge kickbacks from Citadel Securities for order flow while cleverly extracting funds from customers via hidden spreads, poor execution, bogus fees, etc
Totally on board with your thesis as regards ‘index’ bond funds…people at e cargo invest in these vehicles…why in the world would anyone want their fixed income to be marked to market ? If you can afford a decent ladder and be prepared to hold to maturity it’s a fools game .but it seems to me the huge stock index funds are not as amenable to your argument. Esp re large caps….vanguard holds several hundred large caps That a pretty good sample-they don’t have to trade that.
There is another part to the passive story that I witnessed when I used to sit on my former employer's Deferred Comp committee for many years, before retiring. We always hired experts to give us advice and our plan's offerings changed over time from all actively managed funds when I started working there in the early 80s to slowly incorporating more passive funds in this century after the dot com bust, as passive started to gain traction. Then there was a big change a year or two after the GFC. I remember it had to do with some sort of change in ERISA that resulted in our expert advising to start offering target date funds, more low cost passive and also reduce the overall number of choices we had previously offered, which ended up as reducing actively managed funds with higher costs (but we kept a few, particularly in the bond funds, to keep old timers like me happy). If I recall correctly, this had something to due with changes in how the plan sponsor's fiduciary duties were defined by the Labor Department in new regulations. One thing that struck me was when our expert was asked why we should do these things, his reply was that it was what the majority of other plans were doing and we were less likely to get sued for breach of fiduciary responsibility, if we followed what the majority of other firms were adopting as "best practices". In other words, just follow the crowd and you are less likely to get sued.
You would laugh if you saw the investment vehicles offered in my employer 401k lol. I’ve been thinking about it for months and it’s pretty frustrating.
Regarding active bond funds outperforming "passive" , you say 65% of active funds beat the index, can you translate that to excess yield gained? In terms of the 65% of funds and then the relative performance of the entire group. Just wondering.
We are truly in a world of narratives.
From “believing in science” meaning don’t question the authorities, to believing in “global warming” meaning blindly accepting whole slew of ever-changing things, to “believing in passive” meaning don’t bother looking at returns, simply trust all your money to the biggies at Vanguard and Blackrock.
When will this nonsense end?
Could you expand on the effects of passive investing on corporate and treasury bonds separately? I understand how corporate bonds can be distorted, but can treasuries also?
So the epic bond meltdown of 2022 only allowed active to catch up and exceed passive over the past five years? I guess when you consider AGG lost only -13% and not TLT's -31% you can see that being able to hedge, as active is and passive is not, would only close the gap of five years and not more. Will be interesting to see what the next five years holds. Even if "passive" outperforms active by the historical margin going forward it will take some years to erase the 2022 implosion from the relative performance tape. I suspect it will though.
Comparing bond indices to equity indices isn't completely fair. Theoretically, the large market cap of AAPL means market participants expect them to be able to return more value to shareholders than any other equity. A market cap weighted equity index will therefore have a large allocation to AAPL.
A large allocation in a market cap weighted bond index just means that company has a lot of debt. It doesn't speak to investor's expectations of the credit worthiness or likelihood of repayment. In fact, perhaps the opposite in some cases.
Would Enron have been the largest holding in passive high yield funds on the way down purely because the amount of downgraded debt represented such a large share of the high yield market at the time?
Also worth considering, the bond market has many more non-economic actors. Central banks do things for lots of reasons, and it isn't about making the most money on their balance sheet. Ask Harley if he thinks the TIPS market reflects reality or if fed policy distorts those markets.
Great work, Mike! Isn't it that bond funds have difficulties to capture gains from duration when rates decline (because they need to hold their prospected duration, e.g. 7-10 years, constant)? I.e. the (first) Big Short with a twenty year Zero Coupon Bonds in 1982 should have vastly outperformed any (not leveraged) bond fund, no? And by discretion, active managers (when not bound to an average duration) would also outperform if they would not average down with falling yields. Actually, isn't that the magic for bond traders?
I may be a bit late to the party... BUT,
You are certainly not shouting into the void Mr. Green. Firstly, I asked chatGPT to write you a thank you note, and it was far too verbose and full of silly hyperbole. After several attempts to arrive at brevity and substance, I came to the conclusion that chatGPT is a bit of a brown-noser. So I'll just have to give my own.
Thank you sir. Your willingness to sacrifice your time and effort in the pursuit of the greater good has extracted from me (and many others I imagine) respect, attention, and further devotion of my time and effort to finding an actionable course that aligns with your commitment. I understand this influence cannot currently be monetized by you, but please know you have positively impacted both my perspective, and my behavior. I routinely "name-drop" you (and a few others) when finding myself in conversations touching on topics you have engaged in. So perhaps what you have not extracted in dollars (or pick your currency... perhaps bitcoin... sorry, couldn't help myself there) , you have certainly extracted in influence. I see your work as the epitome of what the successful capitalist ideally would be called to as their public service. Thank you for your service.
As for your potential subscription pricing, I recommend in the strongest terms the most affordable pricing you can sleep with at night. I believe our society NEEDS the sort of ideas and perspective you share, which of course requires the least obstruction (such as paywalls) of dissemination possible for maximum effect.
When you’re a geezer, most of the folks running the world today look like teenagers.
In another decade or so they’ll probably all look like toddlers.
If you live longer than that then maybe you go blind, and that solves the problem.
- China set economy growth (very moderate) only 5%
- U.S. facing two banks failure, SVB #SiliconValleyBank Silicon Valley Bank & Signature Bank (*Yellen clue maybe 3rd banks)
yes, U.S. & China can & must cooperate. Not kill each other bcs #Taiwan
https://prada.substack.com/p/silicon-valley-bank-chaos-not-like
Michael , I bought FIG after your recent article, but have yet to figure out how best construct a retirement portfolio in this crazy upside financial world using Simplify.
Passive is anything but passive indeed. It was truly devious of them to use that term to name their so-called new ideology at the time. They had to know that passivity, as defined by Bill Sharpe (thanks for referring back to the wise words of the master of the loser's game), was never going to actually be possible or certainly not at the promulgated low cost. There is nothing passive about investing, no matter how you look at it or approach it. I look forward to la suite!
Well done Mr. Green. "Indexing" or "Passive Investment Management" has been sold as the free lunch of investing ever since "Portfolio Selection" by Harry Markowitz in The Journal of Finance, Vol. 7, No. 1. (Mar., 1952), pp. 77-91
While Harry's paper did illustrate a nice theoretical relationship between the number of securities held and unique risk of those securities, the sales force that extrapolated that relationship to epsilon were the hucksters. We now see the tail routinely wag the dog in market volatility, all the while feeling smug and superior in our indexing and making the index sponsors the new King Midas class.
Agreed. And it’s both sad and amusing to realize that the false narrative that John Bogel sold to the public spawned some copy cats.
Perhaps the most egregious might be Robinhood, who is selling their image of being on the side of the little guy, while taking huge kickbacks from Citadel Securities for order flow while cleverly extracting funds from customers via hidden spreads, poor execution, bogus fees, etc
Totally on board with your thesis as regards ‘index’ bond funds…people at e cargo invest in these vehicles…why in the world would anyone want their fixed income to be marked to market ? If you can afford a decent ladder and be prepared to hold to maturity it’s a fools game .but it seems to me the huge stock index funds are not as amenable to your argument. Esp re large caps….vanguard holds several hundred large caps That a pretty good sample-they don’t have to trade that.