Index trackers

talexuser

Are the Global funds and US funds that were so heavy in the "magnificent" seven now selling Tesla and Nvidia etc contributing to their fall, and investing in the next level of market caps to compensate, or do they have fixed dates for rebalancing in the not so distant future so more pain might come for these stocks down the line?

El_Torro

I don't think it works like that necessarily. S&P funds and global trackers were already exposed to Tesla and NVidia, so since their shares have gone down in value these funds are already reducing their exposure. Still holding the same number of shares, they're just not worth as much as they used to be. 

I don't know how often tracker funds rebalance, though since people are buying and selling all the time I guess this can be done more or less organically. 

GeoffTF

El_Torro said:

I don't think it works like that necessarily. S&P funds and global trackers were already exposed to Tesla and NVidia, so since their shares have gone down in value these funds are already reducing their exposure. Still holding the same number of shares, they're just not worth as much as they used to be. 

I don't know how often tracker funds rebalance, though since people are buying and selling all the time I guess this can be done more or less organically. 

Rebalancing is not needed as the prices of the existing stocks rise and fall, because the price, market capitalisation and market weighting all move in unison. If a new company enters the index (or there is a rights issue), money has to be raised to buy the new stocks. That is raised by selling the same proportion of all the other stacks in the index. Similarly, if a company leaves of there or capital (not a dividend) is returned to shareholders. If you want more details, read the fund prospectus.

Hoenir

Indexes normally change constituents quarterly.  However if a company is acquired , merged or delisted for any reason then the next candidate in line will be promoted to fill the void. 

Weightings and inclusion are generally more nuanced than simply market capitalisation. Free float, liquidity, profitability are some of the factors used. Much depends on the index. MS, for example, will design an index for whatever the customer wants to pays for. 

On a broader note indexes continually self balance. No trading required. Additions and disposals due to capital flows, investment income reinvestment, provision for management charges. Will simply buy or sell the required holdings in the % weighting at the time of the transaction. 

The long standing concern with index trackers is that they are momentum driven, i.e. flow of money.  There's no price discovery. As the AUM of mutual funds increases. There's a decreasing level of active trade. Insufficient to recalibrate an individual share price based on the fundamentals. Stock market has become a numbers game as a result. Watch any daily USstock market commentary show. There's little in depth understanding of the underlying business. The entire focus is on the day's share price movement. Little different to watching a roulette wheel spinning around. 

GeoffTF

Hoenir said:

There's a decreasing level of active trade. Insufficient to recalibrate an individual share price based on the fundamentals.

The academics say that we are nowhere near that.

Hoenir

GeoffTF said:

Hoenir said:

There's a decreasing level of active trade. Insufficient to recalibrate an individual share price based on the fundamentals.

The academics say that we are nowhere near that.

You've edited my original comment. Growth of AUM in the top 20 (US) investment management companies has steadily been increasing for a very long tme. When they come to sell in any quantity. Where's the buyers?  As they are becoming the market. 

Taking fees is a no risk way of making money. 

EthicsGradient

Hoenir said:

Indexes normally change constituents quarterly.  However if a company is acquired , merged or delisted for any reason then the next candidate in line will be promoted to fill the void. 

Weightings and inclusion are generally more nuanced than simply market capitalisation. Free float, liquidity, profitability are some of the factors used. Much depends on the index. MS, for example, will design an index for whatever the customer wants to pays for. 

On a broader note indexes continually self balance. No trading required. Additions and disposals due to capital flows, investment income reinvestment, provision for management charges. Will simply buy or sell the required holdings in the % weighting at the time of the transaction. 

The long standing concern with index trackers is that they are momentum driven, i.e. flow of money.  There's no price discovery. As the AUM of mutual funds increases. There's a decreasing level of active trade. Insufficient to recalibrate an individual share price based on the fundamentals. Stock market has become a numbers game as a result. Watch any daily USstock market commentary show. There's little in depth understanding of the underlying business. The entire focus is on the day's share price movement. Little different to watching a roulette wheel spinning around. 

However, while the proportion of the US market in "active" strategies (though, of course, many active funds can be close to covert trackers) has gone roughly from 98% in 1994 to 50% in 2024, the turnover ratio in world (or US) markets went up (roughly doubled) in the shown period to 2017, which should mean that "price discovery" is now less of a problem than it used to be. Perhaps the academics are right.

GeoffTF

Hoenir said:

GeoffTF said:

Hoenir said:

There's a decreasing level of active trade. Insufficient to recalibrate an individual share price based on the fundamentals.

The academics say that we are nowhere near that.

Growth of AUM in the top 20 (US) investment management companies has steadily been increasing for a very long tme. When they come to sell in any quantity. Where's the buyers?  As they are becoming the market.

I can trade stocks myself or I can delegate the task to a fund manager. In both cases, I can choose to liquidate my holding. In both cases, I will hit problems if there is insufficient liquidity in the market. If I bought individual stocks, and there is no one willing to buy them at any price, I cannot sell them. If I had put my money in an open ended fund, and the fund cannot sell at any price, the fund has to suspend trading. I had put my money in an Investment Trust or ETF, I can sell, but the fund can go to a discount to Net Asset Value (100% discount if no one will buy the fund at any price).

You seem to be worried that there will be no buyers at any price for large and medium capitalisation stocks in developed markets. That could happen. A big asteroid strike or a global nuclear war would do it. Barring that, I am confident that there will be buyers, but they may demand a very low price. You have to accept that if you are in the market, whether you invest directly or delegate the task. Crashes happen.

GeoffTF

EthicsGradient said:

Hoenir said:

Indexes normally change constituents quarterly.  However if a company is acquired , merged or delisted for any reason then the next candidate in line will be promoted to fill the void. 

Weightings and inclusion are generally more nuanced than simply market capitalisation. Free float, liquidity, profitability are some of the factors used. Much depends on the index. MS, for example, will design an index for whatever the customer wants to pays for. 

On a broader note indexes continually self balance. No trading required. Additions and disposals due to capital flows, investment income reinvestment, provision for management charges. Will simply buy or sell the required holdings in the % weighting at the time of the transaction. 

The long standing concern with index trackers is that they are momentum driven, i.e. flow of money.  There's no price discovery. As the AUM of mutual funds increases. There's a decreasing level of active trade. Insufficient to recalibrate an individual share price based on the fundamentals. Stock market has become a numbers game as a result. Watch any daily USstock market commentary show. There's little in depth understanding of the underlying business. The entire focus is on the day's share price movement. Little different to watching a roulette wheel spinning around. 

However, while the proportion of the US market in "active" strategies (though, of course, many active funds can be close to covert trackers) has gone roughly from 98% in 1994 to 50% in 2024, the turnover ratio in world (or US) markets went up (roughly doubled) in the shown period to 2017, which should mean that "price discovery" is now less of a problem than it used to be. Perhaps the academics are right.

An essential point here is that if we take passive investors to be investors who hold the market weight of every stock and do not trade at all, they do not participate in price discovery at all. I am confident that will always be plenty of people who believe they can beat the market, and plenty of people who are suckers for a good active fund manager's sales pitch.

karlxvii

One of the best things about index funds is how simple they are. They automatically adjust to market changes without needing constant rebalancing. GeoffTF made a great point that rebalancing mostly happens when companies enter or leave an index, not just because their prices move around.

As for the "Magnificent Seven," their recent drop just means they make up a smaller share of the index now, with no need for anyone to manually sell. That kind of self-adjusting is part of what makes index investing so effective.

Hoenir raised a good concern about passive investing impacting price discovery, but I think EthicsGradient made a strong counterpoint. Higher turnover ratios suggest we're still a long way from it becoming a real issue. There are still plenty of active traders out there making sure prices stay fair.

Honestly, the recent correction in tech stocks shows that price discovery is alive and well. Overvalued companies eventually get knocked down, no matter how big they are in the index. There will always be investors trying to profit from mispricings, which keeps the market efficient.

If you're worried about concentration risk, it's worth remembering that the market has seen leadership shifts over and over. The current big names won't dominate forever, they never do.