WEBVTT - Are ETFs Killing Future Stock Market Returns? 0:00:05.800 --> 0:00:07.760 Welcome to a Trilliance. I'm Joel Wepper and I'm Eric 0:00:07.800 --> 0:00:13.800 call Tunics. So Eric and all of our time together, 0:00:13.880 --> 0:00:17.480 I think I've missed only a couple interviews and this 0:00:17.560 --> 0:00:20.119 was one of them, which I'm bummed about because you 0:00:20.200 --> 0:00:25.080 went into a research territory and uh and and talk 0:00:25.160 --> 0:00:29.319 to somebody about UM indexing. And I always like to 0:00:29.360 --> 0:00:31.840 know more about this space because it's not maybe directly 0:00:32.440 --> 0:00:37.440 linked to sort of takeaway investment advice, but it informs 0:00:37.760 --> 0:00:40.680 how e t f s are structured and how investors 0:00:40.760 --> 0:00:44.760 might need to think about the space overall. So joining us, um, 0:00:44.840 --> 0:00:48.200 Joining you on this episode of Trilliance was Martin Schmalls, 0:00:48.440 --> 0:00:52.320 who's a professor at the University of Oxford's Business School 0:00:52.360 --> 0:00:55.960 where he teaches finance and economics. He recently wrote a paper. 0:00:56.000 --> 0:00:59.240 CO wrote a paper index funds, asset prices and the 0:00:59.320 --> 0:01:03.160 Welfare of Investors. Why did you want to talk to him? Yeah, UM, 0:01:03.320 --> 0:01:06.039 passive is growing. Ets taken all this money, index fense 0:01:06.080 --> 0:01:09.240 taken all this money, and people like to study them. Um. 0:01:09.400 --> 0:01:11.320 People have been commenting on the rise of passive in 0:01:11.360 --> 0:01:13.480 the worries. You know, it's a whole chapter in my 0:01:13.520 --> 0:01:15.560 vocal book. Some worry and there's been all these worries 0:01:15.560 --> 0:01:18.800 and UM, this particular person I've met over Twitter and 0:01:18.800 --> 0:01:21.960 we've debated a little bit. Nice guy, UM, really smart. 0:01:22.000 --> 0:01:23.399 I think between the two of us, he brings up 0:01:23.440 --> 0:01:25.760 our average i Q about fifteen points. As you can 0:01:25.800 --> 0:01:28.440 see from his credentials, he knows what he's doing and 0:01:28.520 --> 0:01:32.280 he's studied in his latest paper, the idea that index 0:01:32.280 --> 0:01:34.360 funds might even be too good for their own good 0:01:34.400 --> 0:01:38.240 because they're so good and cheap. They're basically allowing more 0:01:38.280 --> 0:01:39.960 people to come into the market and that is going 0:01:40.000 --> 0:01:43.120 to decrease expected returns in the future, which UM is 0:01:43.600 --> 0:01:46.320 to the it doesn't benefit anybody going forward. It's sort 0:01:46.360 --> 0:01:48.760 of like bad for the common good. And this is 0:01:48.920 --> 0:01:52.120 one of a couple other common good arguments UM that 0:01:52.160 --> 0:01:55.440 have been made by academics. So we also discussed common ownership, 0:01:55.720 --> 0:01:57.559 which is another one which we'll go into. I won't 0:01:57.600 --> 0:01:59.760 you know ruin it now, but basically, if you are 0:01:59.800 --> 0:02:03.240 an next funder passive owner, UM, you know what what 0:02:03.440 --> 0:02:05.880 is happening with your money? Like, what are the larger 0:02:06.240 --> 0:02:09.480 ripple effects and implications? Is there anything to worry about? 0:02:09.840 --> 0:02:12.120 Do we need public policy on this and that's what 0:02:12.160 --> 0:02:14.320 we explored, and we covered a lot. You know, I 0:02:14.320 --> 0:02:16.359 know you weren't here, but we I must have asked 0:02:16.400 --> 0:02:21.440 them twenty questions. We delved into it and the deep weeds. 0:02:21.480 --> 0:02:24.519 This is probably why you're needed on this show, because 0:02:25.040 --> 0:02:26.960 I don't think we would have got as deep maybe 0:02:26.960 --> 0:02:29.200 for this episode. It was a good thing though, because 0:02:29.520 --> 0:02:31.440 we really nerded out. But I will say he was 0:02:31.480 --> 0:02:33.359 real good about being short with his answers so he 0:02:33.400 --> 0:02:35.079 doesn't go on and on. It's a it's a nice 0:02:35.080 --> 0:02:38.000 back and forth about several of these sort of concerns 0:02:38.000 --> 0:02:39.799 over the rise of index funds and passive. I think 0:02:39.800 --> 0:02:42.360 you'll enjoy it, especially if you're anybody at all interested 0:02:42.400 --> 0:02:51.240 in how markets work. Is famine Trillians Martin Schmall's alright, 0:02:51.280 --> 0:02:55.440 So Martin, welcome to the show. We've never met in person. 0:02:55.880 --> 0:02:58.360 We've interacted on Twitter here and there, and I've gotten 0:02:58.360 --> 0:03:01.160 to know you a bit over the years through digitally, 0:03:01.160 --> 0:03:02.960 I guess. So it's nice to have you on and 0:03:02.960 --> 0:03:05.360 finally meet you. And I think we have the you know, 0:03:05.440 --> 0:03:08.160 pretty nice civil debates on this, as I do with 0:03:08.240 --> 0:03:12.520 many other people. This concept of passive is a is 0:03:12.520 --> 0:03:15.800 a concept that is studied, because it's getting bigger and bigger. 0:03:15.960 --> 0:03:18.680 As you know, I tend to write off most of 0:03:18.720 --> 0:03:20.680 the worries. A lot of them come from active managers. 0:03:20.960 --> 0:03:23.160 You're an academic, so I think that gives you some 0:03:23.200 --> 0:03:27.400 objectivity that I would give you a little more attention. 0:03:28.040 --> 0:03:30.480 There's a couple issues we're going to bring up. Let's 0:03:30.480 --> 0:03:33.560 go over your latest paper, though, just give me the 0:03:33.639 --> 0:03:36.480 what's it called? Like, what is this sort of thesis called? 0:03:36.920 --> 0:03:38.680 And what is it? What is the worry here that 0:03:38.720 --> 0:03:43.240 you're looking at UM? So the papers called index funds, 0:03:43.600 --> 0:03:46.880 as at prices and the welfare off investors. And I 0:03:46.880 --> 0:03:49.200 wouldn't say that we're looking at a particular warrior. We 0:03:49.240 --> 0:03:51.360 didn't start with the warrior. We started with a question, 0:03:51.400 --> 0:03:56.480 and the question is simply how indexing textbook indexing, you know, 0:03:56.760 --> 0:03:59.760 holding the market portfolio UM would affect the level of 0:03:59.840 --> 0:04:03.400 S prices and how that would affect investor welfare. So 0:04:03.440 --> 0:04:06.760 that's what we started out with. And I suppose one 0:04:06.840 --> 0:04:09.440 could say that it leads to a warrior. I would 0:04:09.440 --> 0:04:12.080 just call it a result, which is that it raises 0:04:12.160 --> 0:04:15.960 a surprices the level of a survices and thereby reduces 0:04:16.279 --> 0:04:20.120 expected returns. That's the baseline of the finding. So Matt Levine, 0:04:20.120 --> 0:04:22.480 who's got away with words, who many people know rich 0:04:22.520 --> 0:04:25.200 for Bloomer opinion. Here's how he put it. An index 0:04:25.240 --> 0:04:27.280 fund is a good way to hold stocks. It has 0:04:27.360 --> 0:04:31.360 low fees and offers their versification. Therefore, if index funds 0:04:31.680 --> 0:04:34.719 are easy and cheap, more people will invest in the 0:04:34.760 --> 0:04:38.560 stock market. Then if there were no index funds, this 0:04:38.600 --> 0:04:40.760 will push up the price of stocks, pushing down their 0:04:40.800 --> 0:04:45.599 expected returns, and therefore index funds are bad for investors. 0:04:45.640 --> 0:04:49.720 So that is exactly accurate. Um, I think pretty much 0:04:49.720 --> 0:04:53.320 every step of the way here should be obvious and 0:04:53.760 --> 0:04:57.240 mostly un arguable, except the last. Perhaps the last one 0:04:57.279 --> 0:04:59.479 at least was not obvious to me, and it's still 0:04:59.480 --> 0:05:01.719 not to present obvious to me. That is just what 0:05:01.800 --> 0:05:05.240 the computer simulations spit out. So bad for investors in 0:05:05.279 --> 0:05:09.600 this case means reducing welfare of investors. That's a welfare 0:05:09.640 --> 0:05:11.320 part in the title. So I totally agree with the 0:05:11.400 --> 0:05:14.200 characterization of Matt Levin that the product. Well, let me 0:05:14.200 --> 0:05:17.160 ask you this, then, is this really an index fund issue? 0:05:17.200 --> 0:05:20.000 Mutual funds were introduced a hundred years ago. You could 0:05:20.120 --> 0:05:22.800 argue they brought in a ton of investors, and up 0:05:22.839 --> 0:05:28.200 until the late nineties of active mutual fund assets or 0:05:28.240 --> 0:05:31.479 mutual fund assets was an active funds. So was that 0:05:31.960 --> 0:05:35.040 a similar issue? Then, like why is it index funds 0:05:35.040 --> 0:05:39.279 and not mutual funds in general? So this is fair 0:05:39.720 --> 0:05:44.159 what you're asking here, and um, there's no distinction in 0:05:44.200 --> 0:05:47.839 the model between an active fund or UM an index fund. 0:05:48.120 --> 0:05:50.279 In fact, there are no active funds in the model. 0:05:50.520 --> 0:05:52.960 The only thing that matters is whether it has become 0:05:53.080 --> 0:05:56.719 cheaper to hold a diversified portfolio. And that's obviously what 0:05:56.760 --> 0:05:59.799 index funds do, and much more successfully than active funds, 0:05:59.800 --> 0:06:03.000 which is you know why I hold inext funds. So 0:06:03.080 --> 0:06:06.520 if active funds had similarly brought down the cost of 0:06:06.560 --> 0:06:11.320 holding a diversified portfolio, they would also riise UM and 0:06:11.600 --> 0:06:16.120 enterprises and thereby reduced returns and as a result of 0:06:16.160 --> 0:06:20.200 reduced investment welfare. So in some ways it's really about financialization. Um, 0:06:20.440 --> 0:06:23.640 then about index fense. I think that's fair. So I 0:06:23.640 --> 0:06:28.119 guess we already concluded that it's not about passive versus 0:06:28.200 --> 0:06:31.840 active as much as much of the debate about passive 0:06:31.839 --> 0:06:35.320 investing really is. So a natural reaction to this would 0:06:35.360 --> 0:06:39.440 be well, some people argue not enough people are invested, 0:06:39.520 --> 0:06:42.680 like here in America only fifty of the population has 0:06:42.720 --> 0:06:45.320 any exposure to stocks and bonds, right, And this is 0:06:45.800 --> 0:06:48.640 added to the wealth gap because you know, you're getting 0:06:48.640 --> 0:06:52.640 that equity market premium and the income from bonds. And 0:06:52.680 --> 0:06:55.480 so as someone who replied to me on Twitter at 0:06:55.520 --> 0:06:59.119 economic he said this, why is it better for people 0:06:59.120 --> 0:07:01.839 to be investors in steef twelve percent return then for 0:07:01.920 --> 0:07:04.920 fifty people to be investors and receive eight percent return? 0:07:05.720 --> 0:07:08.600 I would almost go further and say, well, what about 0:07:08.600 --> 0:07:12.480 a percent investors? Like I guess your thesis almost seems 0:07:12.520 --> 0:07:15.440 like you're rooting for only some people to be invested. 0:07:17.640 --> 0:07:20.160 That's that's a really that's a brilliant question. This is 0:07:20.200 --> 0:07:23.440 really really good. Where do we start? So, first of all, 0:07:23.520 --> 0:07:26.640 it is true that without cheap index funds, you would 0:07:26.640 --> 0:07:31.120 mostly get the very rich and least risk averse people 0:07:31.520 --> 0:07:34.240 to hold the equities, and they would get them for cheap, right, 0:07:34.280 --> 0:07:37.800 because the returns are high because nobody else is buying them, 0:07:37.840 --> 0:07:40.960 And indeed that would lead to a widening of wealth 0:07:40.960 --> 0:07:43.400 and equality. And that is true in the model as well. 0:07:44.120 --> 0:07:47.800 And as you make holding a diversified portfolio cheaper, say 0:07:47.880 --> 0:07:51.320 by the introduction of an index fund, say, um, more 0:07:51.560 --> 0:07:56.480 people invest, And you're exactly right that this actually reduces 0:07:57.040 --> 0:08:00.960 the difference between the expected well of the very rich 0:08:01.000 --> 0:08:04.480 and the middle class. It reduces wealth inequality. So what 0:08:04.600 --> 0:08:06.960 I thought the intuition was going to be of this 0:08:07.040 --> 0:08:10.360 model is that the very rich get harmed by the 0:08:10.400 --> 0:08:14.080 introduction of index funds, but the middle class and you know, 0:08:14.320 --> 0:08:17.080 the poor would actually benefit. But it just turns out 0:08:17.120 --> 0:08:19.800 that this is not the case. It just turns out 0:08:19.960 --> 0:08:23.480 that the middle class had held a much smaller fraction 0:08:23.520 --> 0:08:26.880 of stocks to start with. They also get hurt, and 0:08:27.000 --> 0:08:30.160 get hurt enough by the reduction, and they expected returns 0:08:30.200 --> 0:08:32.520 that on net, they don't actually benefit. And that's a 0:08:32.559 --> 0:08:35.200 surprising part of the result. I'm not sure I like it, 0:08:35.240 --> 0:08:38.440 but that's what the math says. Are you sort of 0:08:38.480 --> 0:08:42.160 saying that index funds or mutual funds in general, especially 0:08:42.200 --> 0:08:44.559 as they get cheaper and cheaper, which again I just 0:08:44.600 --> 0:08:46.520 wrote a book about this called the Bogel Effect. I 0:08:46.520 --> 0:08:49.680 do think that high cost to low cost is the 0:08:49.760 --> 0:08:54.319 real trend, because in mutual funds to ETFs, passive to active, 0:08:54.360 --> 0:08:56.000 there's a lot of gray area there, but high cost 0:08:56.080 --> 0:08:58.079 to low cost, which I think I give Vanguard and 0:08:58.120 --> 0:09:00.480 Bogel a lot of credit for ushering that in. Is 0:09:00.600 --> 0:09:03.880 like everywhere, and clearly the lower thing cost things get, 0:09:04.280 --> 0:09:06.760 the more people will use them. I totally agree. I 0:09:06.800 --> 0:09:08.760 guess my question is, are you sort of saying that 0:09:09.559 --> 0:09:13.120 the cheaper and easier that things get or access points, 0:09:13.840 --> 0:09:16.080 the people who come in later, like in a Ponzi 0:09:16.160 --> 0:09:18.880 scheme are going to get the worst returns than the 0:09:19.040 --> 0:09:21.839 rich people who were already in here. I understand where 0:09:21.840 --> 0:09:25.480 your tradition intuition comes from, but it's not exactly what 0:09:25.920 --> 0:09:28.200 the model says. So first of all, the model is static, 0:09:28.760 --> 0:09:31.440 so there's no such thing as early investors and late investors. 0:09:31.760 --> 0:09:35.520 There's just a comparison bit between. If today you asked 0:09:35.559 --> 0:09:38.400 investors or you measured whether they would be better off 0:09:39.240 --> 0:09:42.840 UM without index funds compared to index funds costing zero, 0:09:43.440 --> 0:09:45.600 the answer would be yes, it would be better off. Okay, 0:09:45.640 --> 0:09:48.160 So it's a comparison within time. It's sort a comparison 0:09:48.320 --> 0:09:51.920 over um time. So there's no Ponzi scheme here in 0:09:51.960 --> 0:09:55.080 the sense of bubble building. It's just a boring statement 0:09:55.120 --> 0:09:59.000 about the level of asset prices being higher, so I think. 0:09:59.040 --> 0:10:01.160 But what I should explain in though, is what what 0:10:01.280 --> 0:10:05.000 exactly I mean by investors being better off without index funds, 0:10:05.120 --> 0:10:09.880 or that index funds harm investor welfare. So let me 0:10:09.960 --> 0:10:13.160 be very clear, for every individual who learns about index 0:10:13.240 --> 0:10:17.440 funds and ditches holding individual stocks and or active expensive 0:10:17.440 --> 0:10:19.679 funds and buys cheap index funds, that's good for them, 0:10:20.080 --> 0:10:23.760 There's no question about it. That's we explained that very 0:10:23.800 --> 0:10:26.439 clearly in the paper. It's a very different statement to 0:10:26.520 --> 0:10:30.080 say investors overall as a group would they be better 0:10:30.160 --> 0:10:33.240 off and the entire distribution of investors would they be 0:10:33.320 --> 0:10:35.800 better off if no index funds were around. So this 0:10:35.920 --> 0:10:38.679 is like a tragedy of the commons problem, right, So 0:10:38.840 --> 0:10:42.000 where you have you have a common resource um that 0:10:42.120 --> 0:10:45.719 gets depleted I don't know whatever fish, atlantic salmon or 0:10:45.760 --> 0:10:48.599 I don't know what, like not farm raised salmon, and 0:10:49.360 --> 0:10:52.880 if left to its own devices, um, individual fishermen will 0:10:52.920 --> 0:10:56.719 buy big, big, big ships and deplete the resource and 0:10:56.800 --> 0:10:59.559 it'd all be better off if there were restrictions on 0:10:59.640 --> 0:11:01.720 the side of ships or the size of the fleet. 0:11:02.120 --> 0:11:04.760 And it's similar in this case. I'm not saying it's 0:11:04.800 --> 0:11:07.400 stupid for an individual to buy index funds. Um. I 0:11:07.559 --> 0:11:12.120 preach um since decades, and I live what I preached 0:11:12.160 --> 0:11:15.280 by buying index funds myself. But that doesn't mean that 0:11:15.400 --> 0:11:18.439 overall it's good for investors that they're around. That is 0:11:18.840 --> 0:11:20.959 really interesting, and I'm glad you admitted that, because that 0:11:21.040 --> 0:11:23.440 was gonna be one of my questions. I have found 0:11:24.040 --> 0:11:26.120 a lot of times you you get a lot of 0:11:26.160 --> 0:11:28.559 attention if you say indexing and passive is going to 0:11:28.640 --> 0:11:30.800 be a bubble, or it's a worry. The press will 0:11:30.840 --> 0:11:33.640 cover you. It's just like any other worry. People who 0:11:33.679 --> 0:11:35.679 worry get a lot of press coverage. So but when 0:11:35.679 --> 0:11:38.240 you add, when you actually ask them what do you hold, 0:11:38.559 --> 0:11:41.520 they'll say index funds, and I'm like, well, then you're 0:11:41.520 --> 0:11:44.120 part of the problem. Or because here's my big question 0:11:44.240 --> 0:11:47.839 is let's just say people listening or I agree with 0:11:48.040 --> 0:11:49.959 this premise, and we all kind of come to the 0:11:50.000 --> 0:11:54.400 inclusion that index funds probably should be somehow curbed. Nobody 0:11:55.040 --> 0:11:58.400 that holds index funds, I can pretty much say them 0:11:58.480 --> 0:12:00.640 is willing to take one for the team and jump 0:12:00.760 --> 0:12:05.600 over to a eighty basis points blend active mutual fund 0:12:06.040 --> 0:12:09.280 for their kids education. They want that money for them. 0:12:09.400 --> 0:12:11.760 So I think part of the issue is, and this 0:12:11.960 --> 0:12:15.600 is like to get your take on this, When Vanguard 0:12:15.720 --> 0:12:17.800 came out in the seventies and they started lowering fees 0:12:17.840 --> 0:12:21.360 over the next forty five years, Active mutual funds didn't. 0:12:21.360 --> 0:12:23.839 They didn't share any economies of scale. And when the 0:12:23.920 --> 0:12:26.360 world kind of turned and the Internet really spread information 0:12:26.880 --> 0:12:30.840 and Vanguard got below ten basis points man that caused 0:12:30.880 --> 0:12:33.640 this frenzy of money to move over to indexing, and 0:12:33.760 --> 0:12:36.280 it was like Active was so far behind at that 0:12:36.360 --> 0:12:39.319 point they they just missed it completely and got disrupted 0:12:39.360 --> 0:12:43.240 by Vanguard big time. And so what you're I think 0:12:44.200 --> 0:12:47.880 experiencing here is just an industry that that failed to 0:12:48.000 --> 0:12:52.120 see what was coming and recognized an opportunity. But we 0:12:52.280 --> 0:12:55.760 are seeing Active lower their fees. So as Active gets cheaper. 0:12:55.880 --> 0:12:57.920 In et F last year, they took in fourteen percent 0:12:57.960 --> 0:13:00.560 of the flows but all went to pretty low us Active. 0:13:01.000 --> 0:13:04.199 So I think the Vogel effect or Vanguard effect is 0:13:04.240 --> 0:13:07.600 actually one that could help solve this because Active gets 0:13:07.679 --> 0:13:09.800 cheaper and more appealing because a lot of people are 0:13:09.840 --> 0:13:12.240 fans of Active, just not the cost, and so as 0:13:12.280 --> 0:13:15.280 it gets lower, you might find a little more balance. 0:13:15.800 --> 0:13:17.480 What do you say about that, like just sort of 0:13:17.520 --> 0:13:20.000 let letting the market figure this out. Well, so I 0:13:20.240 --> 0:13:25.199 agree with um basically everything you said in that Vanguard 0:13:25.280 --> 0:13:28.160 is a cost leader, a price leader is responsible for 0:13:28.600 --> 0:13:31.960 the depression of fees, and every single investor is happy 0:13:32.000 --> 0:13:34.760 about that, right because every single investor has to has 0:13:34.840 --> 0:13:38.400 to pay these fees. Now, if it leads to active 0:13:38.440 --> 0:13:41.880 funds also becoming cheaper, well, that leads to more stock 0:13:41.920 --> 0:13:44.839 market participation. And as we discussed a few minutes ago, 0:13:45.200 --> 0:13:47.520 of course it's desirable on many levels because it's going 0:13:47.559 --> 0:13:50.640 to reduce wealth inequality, right, but it will not solve 0:13:50.679 --> 0:13:53.360 the problem of the essetprises being high and the return 0:13:53.480 --> 0:13:55.440 is being low because it doesn't need to more companies 0:13:56.000 --> 0:13:59.520 producing higher profits for for shareholders. It's just a greater 0:13:59.600 --> 0:14:03.600 sharehold rebays sharing these profits. And again, if you're if 0:14:03.600 --> 0:14:06.000 you just want to reduce wealth inequality, I'm all with you. 0:14:06.400 --> 0:14:11.520 And that's what the model indeed predicts that index fund's 0:14:11.520 --> 0:14:15.560 helped reduce wealth inequality and expected wealth, but every single 0:14:15.640 --> 0:14:17.599 one of the investors is still worse off. They'd be 0:14:17.720 --> 0:14:21.720 better off with the with the ad basis point mutual 0:14:21.800 --> 0:14:25.720 fund from the ninety eighties in terms of their risk 0:14:25.800 --> 0:14:29.400 return trade off compared to everybody else. Right, So the 0:14:29.640 --> 0:14:33.320 resolution of the apparent paradox is, yes, nobody is willing 0:14:33.360 --> 0:14:36.080 to give up their zero percent index fund for an 0:14:36.120 --> 0:14:39.440 ad basis point active fund, except if everybody else would 0:14:39.480 --> 0:14:42.320 do it too. And that's a statement, right, So it 0:14:42.480 --> 0:14:45.320 is not about individuals are being irrational. It is about 0:14:45.800 --> 0:14:49.000 investors as a group are harming each other by driving 0:14:49.080 --> 0:14:51.760 up the asset prices. But they're acting out of their 0:14:51.800 --> 0:14:56.280 self interest though, which it has everybody excerationally, but it 0:14:56.400 --> 0:15:06.680 has to be that way. So this expected return, right, 0:15:07.480 --> 0:15:09.880 is that also just part of the FED, right. The 0:15:09.920 --> 0:15:12.800 FED and central banks around the world kept rates very low, 0:15:12.920 --> 0:15:17.160 did qui Asset prices lifted probably beyond what valuations, you know, 0:15:17.320 --> 0:15:20.080 what earnings would suggest, and it created a little bit 0:15:20.120 --> 0:15:22.320 of a FED bubble. A lot of people thought this 0:15:22.440 --> 0:15:24.480 was the passive bubble. I said, no, it's a FED bubble. 0:15:25.000 --> 0:15:27.720 And they associated the rise of the last fifteen years 0:15:27.760 --> 0:15:30.440 with all the index funds. But now that bubble is broken, 0:15:30.640 --> 0:15:32.440 the FED is hiking. For the past year and a half, 0:15:33.080 --> 0:15:35.480 people still buying index funds, but the market's going down. 0:15:35.640 --> 0:15:37.680 Clearly index funds were not enough to wag the dog 0:15:37.800 --> 0:15:40.240 or anything, and stocks are all over the place. There's 0:15:40.240 --> 0:15:43.440 plenty of dispersion, so I think the hiking sort of 0:15:43.520 --> 0:15:45.920 show that the markets acting pretty much as it does. 0:15:46.600 --> 0:15:48.480 But I guess my bigger point to you is, is 0:15:48.520 --> 0:15:51.080 the expected return being low really more of a function 0:15:51.120 --> 0:15:53.920 of the FED and their policy over the past fifteen 0:15:54.000 --> 0:15:56.840 years rather than just the rise of index funds? Yeah? 0:15:56.920 --> 0:16:00.640 Probably yes, so Uh. The paper does not have the 0:16:00.680 --> 0:16:04.160 addition to try and explain the reasons for declining the 0:16:04.200 --> 0:16:08.440 expected returns or argue that this is primarily driven driven 0:16:08.480 --> 0:16:11.480 by nix fins. The The ambition is really just to 0:16:11.600 --> 0:16:14.200 understand what the effect of indextend an asset prices is, 0:16:14.720 --> 0:16:17.400 and I think probably also shift our thinking on how 0:16:17.480 --> 0:16:21.160 we think about certain policy tradeoffs, such as you know, 0:16:21.920 --> 0:16:25.440 people thinking that indexing necessarily benefits investors, but then there 0:16:25.520 --> 0:16:28.360 might be side effects, and maybe to rein in the 0:16:28.400 --> 0:16:31.280 side effects we would have to harm investors. And this 0:16:31.440 --> 0:16:33.560 is how the tradeoff and the policy debate gets and 0:16:33.760 --> 0:16:37.520 gets characterized. And what this paper shows, um, but the 0:16:37.640 --> 0:16:39.440 math shows is just that this is probably not the 0:16:39.560 --> 0:16:41.440 right way of thinking about it, because it's less than 0:16:41.520 --> 0:16:46.720 perfectly obvious that cheap diversification even benefits investors as a group. 0:16:46.920 --> 0:16:49.880 Of course, it benefits every individual investor, but it's not 0:16:49.960 --> 0:16:53.080 clear that it benefits and as a group. So one 0:16:53.120 --> 0:16:55.240 thing I think that you're talking about and that I 0:16:55.320 --> 0:16:56.560 see in the flows and I want to get your 0:16:56.560 --> 0:16:58.680 take on, is it seems like we're going to move 0:16:58.720 --> 0:17:02.800 into this new world where passive takes up the core 0:17:02.880 --> 0:17:06.080 of most portfolios, and then people are going to look 0:17:06.119 --> 0:17:08.640 for something that's very, very different than passive to sort 0:17:08.680 --> 0:17:10.880 of decorate with almost like adding a little hot sauce 0:17:10.920 --> 0:17:13.879 and otherwise boring meal. This is the lane that like 0:17:14.040 --> 0:17:18.040 Cathy Wood lives in an arc even crypto um. And 0:17:18.160 --> 0:17:20.639 I think active managers over time are either gonna have 0:17:20.680 --> 0:17:22.680 to get cheap or shiny. They're going to have to 0:17:22.760 --> 0:17:28.800 be really producing some high returns two A attract investors 0:17:28.880 --> 0:17:31.520 attention and be get used as a compliment. And so 0:17:32.000 --> 0:17:36.640 could you argue that over time that active slice will 0:17:36.760 --> 0:17:39.320 start to produce some really big winners and you will 0:17:39.400 --> 0:17:42.400 see some money go to those more active active managers, 0:17:42.920 --> 0:17:45.879 and the net result will be a rooting out of 0:17:45.920 --> 0:17:48.800 the bad managers giving money to the good ones, um, 0:17:48.920 --> 0:17:51.239 and you still will have active setting prices. Is there 0:17:51.240 --> 0:17:54.120 anything wrong with that world. I don't see that there's 0:17:54.119 --> 0:17:57.080 anything particularly wrong with that world. Nope. I think that's 0:17:57.200 --> 0:18:00.320 that's probably a reasonable prediction. But I would have to 0:18:00.359 --> 0:18:02.600 admit that I have not done a whole lot of 0:18:02.920 --> 0:18:06.119 research on how enterprises get set when active and passive 0:18:06.160 --> 0:18:09.040 managers coexist. I find that that distinction I think you 0:18:09.119 --> 0:18:12.320 alluded to it. I find that distinction not super useful 0:18:12.640 --> 0:18:15.560 these days. Whereas you know, it qualifies as a passive 0:18:15.640 --> 0:18:19.040 fund to follow an index that is a bespoke index 0:18:19.160 --> 0:18:22.320 just designed to follow a particular portfolio. And so when 0:18:22.400 --> 0:18:25.159 when I say passive, I really mean, you know, market 0:18:25.240 --> 0:18:27.800 level indexing like in the textbook, which is different from 0:18:27.920 --> 0:18:30.400 what passive means in in the real world these days. 0:18:30.480 --> 0:18:32.320 But just to be clear, I think what has happened 0:18:32.320 --> 0:18:34.600 because the S and P isn't even passive. I mean 0:18:34.640 --> 0:18:38.040 there is run by a committee. Um, there's rules, and 0:18:38.080 --> 0:18:40.000 then you get to other indexes like the Russell one 0:18:40.040 --> 0:18:43.160 thousands a little different. I mean, I think really your 0:18:43.240 --> 0:18:46.800 point is more about just people in funds rather than 0:18:47.320 --> 0:18:51.000 you know, people buying funds today holding them because they're 0:18:51.080 --> 0:18:55.560 cheap and good rather than passive and active. Um yeah, 0:18:55.560 --> 0:18:58.240 I think so, yeah, very much. The true benchmark would 0:18:58.240 --> 0:19:02.240 be you holding a market value waited portfolio of all 0:19:02.640 --> 0:19:04.960 the world's risky assets, right, And I think we can 0:19:05.000 --> 0:19:06.720 all agree that the S and P five is not 0:19:06.800 --> 0:19:09.560 that Not even you as equities is that, right. So 0:19:09.680 --> 0:19:12.560 in theory you have to have exposure to Chinese real 0:19:12.720 --> 0:19:14.399 estate or I don't know what, right, So this is 0:19:14.440 --> 0:19:18.240 true passive in the textbook, and anything that's labeled passive 0:19:18.320 --> 0:19:21.520 these days is very far removed from that. So for 0:19:21.640 --> 0:19:23.800 for that reason alone, I don't think a lot of 0:19:23.840 --> 0:19:27.040 the headline discussion and the public discussion about passive verse 0:19:27.080 --> 0:19:29.479 effective makes a whole lot of sense, because look, if 0:19:29.520 --> 0:19:34.320 I build a portfolio of passive funds, but every of 0:19:34.400 --> 0:19:37.399 these passive funds contains one stock, then this is literally 0:19:37.440 --> 0:19:39.920 the same thing as active investing. So I don't think 0:19:40.000 --> 0:19:43.200 that that these labels are as meaningful as they perhaps 0:19:43.280 --> 0:19:45.960 used to be fifteen years ago. I agree, Um, there's 0:19:46.000 --> 0:19:47.920 just too much gray area. I still use it because 0:19:47.960 --> 0:19:50.520 you have to communicate quickly sometimes, but that's very totally 0:19:51.160 --> 0:19:53.960 That's why I again I go back to our phrase 0:19:54.000 --> 0:19:56.640 the great cost migration. Most of this is just high 0:19:56.680 --> 0:20:01.040 cost low cost. What makes pass passive was ninety basis points, 0:20:01.119 --> 0:20:04.280 it would be fringe at best. Um, it's because it's free. 0:20:04.760 --> 0:20:07.880 That's why it's a big deal. Um, let's let's move 0:20:07.960 --> 0:20:09.960 to to what should be done here? I mean, is 0:20:10.000 --> 0:20:13.560 there any real solution here or is it just Hey, 0:20:13.840 --> 0:20:17.200 there's more people invested. The FED lowered rates for fifteen years. 0:20:17.680 --> 0:20:19.240 It's created It created a little bit of a of 0:20:19.320 --> 0:20:21.439 a bubble. And now look, returns are gonna be low 0:20:21.440 --> 0:20:24.600 for a while because of the you know, sort of 0:20:24.680 --> 0:20:26.760 a return to the mean, Like you can't escape the mean, 0:20:27.200 --> 0:20:29.920 so you're gonna have lower turns. Is that generally the take? 0:20:30.040 --> 0:20:32.960 Or is there a way to solve this? So I 0:20:33.400 --> 0:20:36.639 don't think that there is immediate policy implications from this paper, 0:20:36.720 --> 0:20:38.399 but rather that we should think of it as a 0:20:38.480 --> 0:20:43.840 stepping stone to towards thinking more accurately about what other 0:20:43.960 --> 0:20:47.040 policy tradeoff should be about. So, um, you know, I 0:20:47.760 --> 0:20:50.879 did a bunch of research on how diversified ownership of 0:20:51.000 --> 0:20:55.560 firms might affect competition, and these policy trade offs look 0:20:55.600 --> 0:20:59.600 completely different. Um, once you endotonize, a survises, So what 0:20:59.640 --> 0:21:01.520 I mean by that is once you take it into 0:21:01.560 --> 0:21:05.879 account the effect of diversified ownership on asset prices, then 0:21:06.000 --> 0:21:08.600 if you basically ignored that link. So I don't think 0:21:08.600 --> 0:21:11.080 the paper itself has a problem that needs to be 0:21:11.200 --> 0:21:14.359 solved and therefore no policy implications, but I think it 0:21:14.480 --> 0:21:18.520 informs how we should think about other side effects that 0:21:18.720 --> 0:21:21.159 people have debated in passive. So let's talk about one 0:21:21.200 --> 0:21:23.000 of those, which you wrote about and I covered in 0:21:23.040 --> 0:21:25.680 my book as well, which is called common ownership, which 0:21:25.720 --> 0:21:31.080 is very communist, communist side term. That's basically I'll summarize it. 0:21:31.119 --> 0:21:33.600