One underappreciated feature of passive - as long as it's linked to market cap indices - is the structural benefit of sticking with winners (and adding via share buybacks as you point out) and cutting the losers. This is very slow / inefficient through changes in weightings and index composition, but still better than what most individual investors would achieve on their own. If people would hold their S&P exposure through 500 single stocks, they would have sold NVIDIA many times over and re-balanced to seemingly cheap value traps which have been shed from the index in the meantime. I suspect this phenomenon is also part of the under-performance of active funds.
I guess the reductio ad absurdum concept is, what if every investor, individual and institutional, went passive? would the stock market still perform a useful function?
The reverse DCF is somewhat popular to gauge what is priced into a stock, which assumes that what the market is factoring in for the future economic factors of the company being analyzed is what matters for the stock price. You can then gauge how the assumptions that are priced into the stock compare to your own. If what you're saying is correct - the price setter has shifted from investors that invest based on fundamental analysis to flows from buybacks and passive - do you think this style of analysis using a reverse DCF wouldn't work? Or rather, it is not an accurate assessment of what is priced in per se?
You may enjoy @michaelwgreen 's content on the distortive effects of passive on markets. Price inelasticity, employment-linked pension flows, and static asset allocation devoid of considerations for fundamentals, are covered in great depth.
One underappreciated feature of passive - as long as it's linked to market cap indices - is the structural benefit of sticking with winners (and adding via share buybacks as you point out) and cutting the losers. This is very slow / inefficient through changes in weightings and index composition, but still better than what most individual investors would achieve on their own. If people would hold their S&P exposure through 500 single stocks, they would have sold NVIDIA many times over and re-balanced to seemingly cheap value traps which have been shed from the index in the meantime. I suspect this phenomenon is also part of the under-performance of active funds.
I guess the reductio ad absurdum concept is, what if every investor, individual and institutional, went passive? would the stock market still perform a useful function?
I.think that's the point. Market is purely for wealth transfer - not capital allocation
The reverse DCF is somewhat popular to gauge what is priced into a stock, which assumes that what the market is factoring in for the future economic factors of the company being analyzed is what matters for the stock price. You can then gauge how the assumptions that are priced into the stock compare to your own. If what you're saying is correct - the price setter has shifted from investors that invest based on fundamental analysis to flows from buybacks and passive - do you think this style of analysis using a reverse DCF wouldn't work? Or rather, it is not an accurate assessment of what is priced in per se?
Share buybacks just seem to happen regardless these days... I doubt most CEO think.about valuation
You may enjoy @michaelwgreen 's content on the distortive effects of passive on markets. Price inelasticity, employment-linked pension flows, and static asset allocation devoid of considerations for fundamentals, are covered in great depth.
https://open.substack.com/pub/michaelwgreen?utm_source=share&utm_medium=android&r=sbjt
Yes - I know Michael is not a fan... but it's been the best way to invest for last 10 years....
Can't fight it. The question is when do we start to fade it? What are the signals we should be looking for