Is there an exagerated impact of Tracker funds on Stock Market movements?

Suffolk_lass

I have begun my plan to research investments as well as savings this year. Oh my! I am reading the finance pages, a couple of books and following a few threads on here and my goodness, there are differing views represented.

My guiding principles have always been at the less adventurous-more cautious end of the spectrum - mostly because I cannot bear to lose what I have earned and paid tax on.

I have been looking at the area of tracked funds and I now believe a lot of the stock market volatility is caused by an artificial reaction driven by computerised passive tracker funds where the algorithm automatically triggers a sale when the movement of a holding exceeds a certain percentage. And one triggers another, and the reaction goes on. Is my understanding of how they work correct?

Where a fund is actively managed, there is a human intervention to buy and sell, prompted by the dashboard alert of a computer algorithm, but with that sanity moment added (hopefully).

I was also listening to an interview Neil Woodford did with one of the investment companies and he was talking about continuing to hold certain things because they are undervalued, even though they have fallen in price. Given the huge amount of influence he has and the vast amounts of money in his funds over the last 18 months, I found myself wondering what the impact of a Woodford fund selling might have on that group or Company in light of the passive tracker growth.

There are so many more experienced people in this area of the forum I wondered what do others think?
SL

TheTracker

Suffolk_lass wrote: »

I have been looking at the area of tracked funds and I now believe a lot of the stock market volatility is caused by an artificial reaction driven by computerised passive tracker funds where the algorithm automatically triggers a sale when the movement of a holding exceeds a certain percentage. And one triggers another, and the reaction goes on. Is my understanding of how they work correct?

SL

The effect is small. Some predict that you'd need to go well over 90% for any effect to ramp up. The market does need active participants to set prices. Even without your standard investors there will be mergers and acquisitions, stock options being exercised, etc that can set prices. If only 20% of trades were active, would it matter that 4 times as many investors were following the football match and tracking what those 20% did? Probably not. And by the way, easily mathematically provable, those 80% would still gain more than the other 20% on average.

Another argument is that the market may actually become more efficient if more investors switched from active to passive. Active investors make money by exploiting pockets of inefficiency in the market where assets are inappropriately priced, in their view. By taking out Joe public in particular we remove a lot of behavioural trades. Less money piling into Tv Traders like Woodford, and assets du jour.

There are many other hypotheses for what would happen if trackers swamped the market. Another is that trading fees would go up as the average fund may have less assets under management and customers. This would exacerbate the already significant different in fees between active and passive funds.

Index tracking funds do have a few downsides though.
- they usually rebalance less often than optimal
- they are forced to buy and sell even when those assets are inconsequential, increasing trading costs
- some active managers "front run", buying or selling assets that are due to enter/exit indices just before the index fund is forced to buy or sell them.

However, these effects are small are reflected in the public tracking errors.

In short, your concerns are largely baseless compared to all the other concerns you should have.

The first step you should take is educating yourself about why investments make money at all. In a nutshell there is no gain without pain. The fact that prices can swing around wildly is what lends them a small return premium over time. So if you really are that risk averse you can't hope to make much return. Chances are though that you aren't as risk averse as you think you are, particularly when you learn to distinguish daily, monthly, and yearly volatility from the multi decade timescale you probably intend to invest against.

jimjames

I can't see any real impact of tracker funds buying and selling other than when a stock enters the index.

If a market isn't moving then the tracker price will be static. Others buying and selling will drive the price. You might be more concerned about short selling or other such practices.

Linton

Retail funds only own about 10% of the total market and only a fraction of those are trackers. So any effect will be very small.

Suffolk_lass

TheTracker wrote: »

The first step you should take is educating yourself about why investments make money at all. In a nutshell there is no gain without pain. The fact that prices can swing around wildly is what lends them a small return premium over time. So if you really are that risk averse you can't hope to make much return. Chances are though that you aren't as risk averse as you think you are, particularly when you learn to distinguish daily, monthly, and yearly volatility from the multi decade timescale you probably intend to invest against.

Thanks to all for your reassurance - as I say I am fairly new to this - Thanks TheTracker in particular for the explanations and I hope you are right, my caution is because I like to understand what the risks are and how things work. At the moment there are so many different views expressed by commentators and "experts" that I am struggling to make sense of it.

It feels a bit like my online betting account at the moment - I made a healthy profit doing something really simple and then got a bit over confident and blew most of it by straying into things I did not understand properly.:o

Thanks again
SL

tg99

TheTracker wrote: »

The effect is small. Some predict that you'd need to go well over 90% for any effect to ramp up. The market does need active participants to set prices. Even without your standard investors there will be mergers and acquisitions, stock options being exercised, etc that can set prices. If only 20% of trades were active, would it matter that 4 times as many investors were following the football match and tracking what those 20% did? Probably not. And by the way, easily mathematically provable, those 80% would still gain more than the other 20% on average.

Another argument is that the market may actually become more efficient if more investors switched from active to passive. Active investors make money by exploiting pockets of inefficiency in the market where assets are inappropriately priced, in their view. By taking out Joe public in particular we remove a lot of behavioural trades. Less money piling into Tv Traders like Woodford, and assets du jour.

There are many other hypotheses for what would happen if trackers swamped the market. Another is that trading fees would go up as the average fund may have less assets under management and customers. This would exacerbate the already significant different in fees between active and passive funds.

Index tracking funds do have a few downsides though.
- they usually rebalance less often than optimal
- they are forced to buy and sell even when those assets are inconsequential, increasing trading costs
- some active managers "front run", buying or selling assets that are due to enter/exit indices just before the index fund is forced to buy or sell them.

However, these effects are small are reflected in the public tracking errors.

In short, your concerns are largely baseless compared to all the other concerns you should have.

The first step you should take is educating yourself about why investments make money at all. In a nutshell there is no gain without pain. The fact that prices can swing around wildly is what lends them a small return premium over time. So if you really are that risk averse you can't hope to make much return. Chances are though that you aren't as risk averse as you think you are, particularly when you learn to distinguish daily, monthly, and yearly volatility from the multi decade timescale you probably intend to invest against.

I'd hardly call Woodford a 'tv trader'.

TheTracker

tg99 wrote: »

I'd hardly call Woodford a 'tv trader'.

The comment was in the context of the OP who was listening to an interview with NW. I guess it could have been radio?

Anyway, I typed Neil Woodford into a large search engine, clicked on video, and lo and behold dozens of recent tv interviews conducted with the Legend popped up. "Britain's top fund guru" / "I saw the Great Fall of China" / "avoiding future turmoil" / "years of turmoil" / "investors now need me more than ever" ... and that's just the first page of search results. TV Trader.

Suffolk_lass

For the record, the interview I saw and heard was sent to me by Fidelity and was with their Funds manager so I don't know if it would have been the same as the TV clips you refer to. I receive regular emails from them and this was a web interview I watched on my phone. It was in a little more depth than the average TV or Radio interview which I would collectively describe as superficial.

What I do note is that Neil Woodford has given lots of interviews in the last month, just before his company offers a further capitalisation shares issue. It does not take an experienced investor to spot the link!

What is an OP please?
SL

TheTracker

original post(er)

tg99

TheTracker wrote: »

The comment was in the context of the OP who was listening to an interview with NW. I guess it could have been radio?

Anyway, I typed Neil Woodford into a large search engine, clicked on video, and lo and behold dozens of recent tv interviews conducted with the Legend popped up. "Britain's top fund guru" / "I saw the Great Fall of China" / "avoiding future turmoil" / "years of turmoil" / "investors now need me more than ever" ... and that's just the first page of search results. TV Trader.

All fund managers have to do a degree of TV interviews, press articles etc as there is a demand to meet from investors (both existing and potential) who like to 'see the whites of the eyes' and understand how the portfolio is positioned, the strategy employed, etc etc. Obviously it is hard to distinguish the primary intention but personally I'd be more concerned with fund managers who spent all their time on the road, appearing on CNBC etc rather than concentrating on running the portfolio which is primarily what they are employed to do. From my experience Woodford does not fall into this category.

Anyhow it was more the word 'trader' I'd dispute as that term conjures up the image of short term buying and selling of stocks which clearly some fund managers do whereas Woodford tends to have a much more longer term view and lower turnover / longer holding period so I don't really think you would call him a 'trader'.

TheTracker

tg99 wrote: »

All fund managers have to do a degree of TV interviews, press articles etc as there is a demand to meet from investors (both existing and potential) who like to 'see the whites of the eyes' and understand how the portfolio is positioned, the strategy employed, etc etc. Obviously it is hard to distinguish the primary intention but personally I'd be more concerned with fund managers who spent all their time on the road, appearing on CNBC etc rather than concentrating on running the portfolio which is primarily what they are employed to do. From my experience Woodford does not fall into this category.

Anyhow it was more the word 'trader' I'd dispute as that term conjures up the image of short term buying and selling of stocks which clearly some fund managers do whereas Woodford tends to have a much more longer term view and lower turnover / longer holding period so I don't really think you would call him a 'trader'.

Fair enough. I didn't mean anything terribly negative about it. I guess most of his fee paying investors would rather that instead of TV parades he was having important discussions about tobacco and pharma companies.