Skip to main content

Bias For Clarity

Bias for action. Gets things done. Go-getter. Traits companies big and small look for. And for good reason, you're being hired to do things! However, action is a secondary step that often overshadows the primary step, direction.   Clear direction is the foundation that enables our actions to takeoff. Without it, we're stuck in the mud.  Striving for clarity is an underrated skill. Having the courage to ask ( seemingly ) obvious questions, and to check in, making sure we're all on the same page. "O bvious " questions are a low risk, high reward way to add value. At worst, you'll add confidence to our actions. At best, you discover a misalignment that saves us from a dead-end.  The more people, the more clear we need to be. The bigger the initiative, the bigger the risk of reaching the finish line, only to realize expectations were off.  Success is always uncertain. But we can be certain about what we want and what everyone's job is. Things that can be clea

The Big Fuss - Bursting the Index "Bubble"

Macro Focus Photo of a Bubble

As passive investing becomes more popular, there's growing concern around indexing and its impact on the integrity of the stock market. Michael Burry, portrayed by Christian Bale in The Big Short  for famously predicting the 2008 collapse, went as far as calling it a "bubble".

“This is very much like the bubble in synthetic asset-backed CDOs before the Great Financial Crisis in that price-setting in that market was not done by fundamental security-level analysis, but by massive capital flows based on Nobel-approved models of risk that proved to be untrue.” - Michael Burry

These concerns stem from indexing's lack of price discovery. Unlike active trading which involves analysis, passive investing simply buys stocks relative to their size in an index.

Trading sets prices, each trade is a vote for a stock's value. Critics fear that passively investing based on relative size will drive up the price of larger stocks and suppress the price of smaller stocks.

Luckily, ETF trading doesn't necessary equal stock trading. Most ETF trading happens in the secondary market (ETF shareholders trading between each other). These trades do not involve trading the underlying stocks, so there is actually no impact on stock prices. 94% of ETF trading is done on the secondary market.

The remaining 6% happens on the primary market. Primary market trading only happens when an Authorized Participate (AP) needs to creates new ETF shares (which results in the buying of the underlying stocks) or redeem existing shares (which results in the selling of the underlying stocks). An AP does this whenever there is excess ETF demand or supply, respectively.

Index strategies only account for 5% of total stock trading. An overwhelming majority is still done by active managers. Active managers are the ones setting prices.

Yes, indexing is growing. However, in terms of total stock holdings, they're still a small player. Only 17.5% of stocks are owned by index strategies. Critics flag that this is only the beginning and indexing will continue to grow (which is likely true), but this shouldn't be cause for concern. Remember, trading sets prices, not asset size. As long as the majority of trading is done by active managers, there will be sufficient price discovery to keep markets efficient.

The self-correcting nature of markets make it hard to imagine a time where all trading is passive. This would lead to inefficient markets. Inefficient markets create opportunities to profit. These opportunities attract active investors. Active investors create efficient markets. Perfectly balanced, as all things should be.

Index funds are not creating a "bubble". Be mindful of where these claims come from. Most are from underperforming active managers who are losing business to passive strategies. This is actually an argument for indexing making markets more efficient. By weeding out poor performers, only the highly-skilled remain, which leads to even better price discovery. Ironic, I know.


Popular posts from this blog

The Art of Giving Feedback

Constructive feedback is an awkward affair. You don't want hurt feelings, but recognize the importance of honesty. You've tried the classic "hoping things will get better on its own" and unfortunately it hasn't played out. When giving feedback, here are a few things that I try to keep it mind. Start with empathy. Step into their shoes and understand their story. If you don't know, ask. Be genuinely curious. Feedback is a dynamic affair. Shared communication with a shared goal towards progress. Take the emotion out of it. Focus on the situation, not the person. Focusing on the person adds unnecessary weight to an already emotionally-bloated event.  Be specific. Give clear examples. Vague feedback equals dismissed feedback.  Doing above won't de-awkward things fully, but it will dampen it and increase the chance of better outcomes. 

Negative Feedback, Positive Lessons

In the battle against plastic bags, a five-cent tax was shown to be much more successful at deterring usage than a five-cent credit for bringing your own bags. Carrots satisfy but sticks sting, and they sting hard. So we default to the less painful choice of avoiding loss. Loss aversion impacts the way we process information. A 2019 study  invited participants to learn through a series of multiple choice questions. Each question only had two options to choose from. Whether guessing correctly or not, they would still learn the right answer.  Despite the identical learning opportunity, participants were much more successful at recalling the answers they guessed correctly than those they got wrong.  "You're right!" feels good. We savour the moment, analyzing every detail.  "You're wrong!" stings. We want to quickly forget, dismiss, and move on.  When we succumb to loss aversion, we miss opportunities to learn. Failure is part of the process. We'll experie

ELI5: Stock Buybacks

Stock buybacks have been in the hot seat. Companies of all shapes and sizes are facing criticism for their "excessive" buyback programs. Today we breakdown what buybacks are and if they're really as bad as people say. What is a Stock Buyback? A stock buyback is exactly what it sounds like. A company buys back  stock. Also referred to as a  shares repurchase . Done either by  tender offer or in the open market . A tender offer is a proposal to shareholders which outlines the number of shares a company is willing to buy and the price they are willing to buy for. Shareholders can either accept or decline. There's no obligation on their end. More commonly, a company will simply repurchase shares in the open market. Why Would a Company Buy Back Their Own Stock? When companies have excess cash, buybacks are a way to distribute wealth to their shareholders. Buybacks reduce the number of outstanding shares, driving prices up and increasing shareholder