What do ETFs and Karl Marx have in common?

Posted: 7 September 2016 in Uncategorized
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I know, it sounds like the setup for a bad joke. But, for the authors of a recent Sanford Bernstein research report titled “The Silent Road to Serfdom: Why Passive Investing is Worse Than Marxism,” it’s a very serious matter.

Their argument is pretty straightforward (although the report itself, according to all accounts, is long and meandering): the rise of passive and quasi-passive asset management (e.g, exchange-traded funds that track major equity indexes, like the S&P 500 Index or the Russell 2000 Index, in addition to “smart beta” funds that invest based on historically predictive factors) are threatening to fundamentally undermine the entire system of capitalism.

Why? Because, in their view, the growth in such passive and algorithmic funds has caused markets to become more correlated, as all the funds are based on buying all the same stocks for the same reasons. And a market that is more correlated, they argue, will do a worse job of allocating capital.

The alternative are actively managed funds (with all their high fees and exorbitant profits and salaries), directed by analysts who are constantly thinking about whether companies are over- or underpriced, so that they can follow the price signals and buy the underpriced ones and sell the overpriced ones and keep capital flowing to its best possible uses.

So, the Sanford Bernstein team writes:

A supposedly capitalist economy where the only investment is passive is worse than either a centrally planned economy or an economy with active market led capital management.

Of course, the entire premise of their argument is that the buying and selling of stocks on Wall Street creates an efficient allocation of resources, which as I showed yesterday is a myth. Very few actively-managed mutual funds routinely outperform the market and, given the short time span (days, hours, and even microseconds), most Wall Street trading simply cannot affect the allocation of real resources.

But, to my mind, the rise of ETFs and other forms of passive and quasi-passive management is interesting for a very different reason. At the limit, they point toward the creation of a single, most efficient robot trader, which might actually solve the socialist calculation problem. In this sense, they threaten to displace all the Wall Street traders and analysts, just as the rise of credit and the joint-stock company rendered the capitalist superfluous to capitalist production.

So, perhaps the folks at Sanford Bernstein are right: passively managed stock funds represent Marx’s revenge on capitalism.

  1. As you say, trading stocks mostly moves money between speculators and doesn’t supply capital to the firm themselves. Firms raise capital through private early-stage investors, and though IPOs which are really a closed round of private investment with a commercial bank just days before listing. Listing the company pays off those early investors and merchant bankers, and you could argue that justifies the existence of stock markets but it’s quite tenuous.

    Firms could raise capital in the stock market with new share issues after IPO but that’s quite rare. The opposite (buybacks) is common. The only way stock markets help firms raise capital long after being listed is through mergers and acquisitions (paid partly in shares) and inasmuch as a higher stock valuations help firms get cheap credit.

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