I'm a brand new subscriber here, but I've dabbled in /r/personalfinance for the past couple of years.
One of the things I've learned about in /r/pf is ETFs, or index funds. I'm not going to claim 100% knowledge on how they work, but essentially from what I understand, a financial institution like Vanguard starts a fund designed to pattern itself after an index like the S&P 500, and instead of buying and selling each day based on market trends, as they get new cash from investors they allocate it in the specific ratios that mimic those indexes, and re-balance as necessary.
So, that got me to thinking...
As the trend shifts more and more towards ETFs for individual investing, these funds control more and more of the outstanding shares of many companies. Additionally, any stock which maintains a position in one or more large indexes essentially has a constant source of new buys as those funds add investor dollars, regardless of their company performance. The only thing they can do to lose that is jeopardize their placement in their index.
Twenty years ago, this wasn't really such a big deal, but now these funds are growing exponentially and gain hundreds of billions of dollars each year in invested capital.
So, let's say "Company X" is in the S&P 500 and a Tech company. One day, they announce their quarterly results and they miss projections causing their stock to drop as individuals and active funds sell positions to reduce damage. Then, what happens over the next few days? Well, IRAs and 401ks using VOO and other similar funds have the stock as an auto-buy to keep their ratios. They acquire the shares that the risk averse fund managers seek to discard, and when the supply is exhausted, they start getting their shares from other individuals and fund managers as their asking prices are met. They take what should be a bear, and get bullish on it due to the nature of the indexes and their need to consume.
It's kind of like a small scale version of when Volkswagen became the highest valuation company a few years ago because their stocks were needed to fill an order but not available, so the price completely outgrew the performance of the company. These stocks aren't recession-proof but their constant demand keeps them inflated since performance and predictions aren't the only things creating demand.
On the flip side, take a stock which is being purged from an index... If funds are dumping their positions in that stock because they no longer help pattern the index, that glut of supply is going to create a soft spot that outpaces whatever issue was causing the stock to get kicked out to begin with.
If all of the above holds true, isn't there an advantage just in knowing which stocks are held by the most index funds (by volume)? It would seem like an individual investor would be inclined to buy into more widely held fund stocks knowing there is a set demand for them, and to abandon positions or short stocks which will be sold off as funds re-balance after an index change.
Does this make sense? Is it fundamental knowledge for any investor already, or is there a flaw to my understanding which I'm missing? I feel like both are probably true. Watching the market hiccup these last couple of months makes me feel like there's something to it. Stocks drop, and then new money rushes in and they get back their losses. There are dips, and there was a "correction" but mostly the market feels like it's going to keep pushing forward even though it's already a year or two late for a bursting bubble according to many people. I feel like ETFs are the reason that bubble hasn't burst yet, and why when it does it won't burst as badly as expected for as long as it should.
Thanks for your time and any discussion you add. I appreciate any criticisms and filling in any obvious blanks I missed along the way.
Submitted May 04, 2018 at 11:56PM by DevsMetsGmen https://ift.tt/2FIb4L7
