Felix Salmon

Equities: The shift from active to passive

Felix Salmon
Aug 31, 2010 20:58 UTC

Sam Mamudi has found a new way to slice mutual-fund data, and the results are very interesting: the flows aren’t just from domestic funds to international funds, as we can see from the monthly ICI data, but also from actively-managed mutual funds to index funds.

Since the end of 2005, actively run U.S. stock funds have seen net outflows every year, totaling $369 billion, while indexed counterparts — not including exchange-traded funds — have seen net inflows of $112 billion, according to fund-industry trade group the Investment Company Institute.

I went one further, and had a look at the ICI’s data on ETF flows. After all, to a first approximation, all ETFs are index funds rather than actively-managed.

Here’s how the numbers break down: total actively-managed mutual funds, both domestic and international, saw a net outflow of $37.7 billion in 2009, and of $24.1 billion in the first seven months of 2010. Meanwhile, passively-managed index funds saw a net inflow of $22.9 billion in 2009, and of $22.4 billion in 2010 so far. But get this: equity ETFs saw net inflows of $69.3 billion in 2009, and another $21.4 billion in 2010 to date.

Those numbers aren’t publicized by the ICI: I had to calculate them using their spreadsheet of monthly ETF data. But if you add it all together, there was a net inflow into equities of $60.5 billion in 2009, and another net inflow of $19.8 billion in the first seven months of 2010. People aren’t pulling their money out of the stock market, they’re just pulling their money out of actively-manged mutual funds in general, and actively-managed domestic mutual funds in particular.

If you look at growth rates, the numbers are even starker. Actively-managed domestic mutual funds saw an outflow of $44 billion in the first seven months of 2010, which was 1.45% of their total value. Equity ETFs, by contrast, saw an inflow of $21.4 billion, which was 3.12% of their total value. If you go back to 2009, the numbers are -2.07% and +10.78%, respectively. Yes, in 2009, the net inflow into equity ETFs (I’m not even including bond or commodity ETFs, here) was greater than 10% of their entire year-end value. Mutual funds, it’s fair to say, never see those kind of net inflows.

This shift is only just beginning. There’s more than $3 trillion invested in actively-managed domestic mutual funds, compared to just over $1 trillion in domestic index funds and domestic equity ETFs combined. On the international side, there’s $1.2 trillion in actively-managed mutual funds, compared to $218 billion in international ETFs, and just $97 billion in international indexed mutual funds.

So in terms of long-term investments, people are still massively overweight actively-managed strategies. But they’re sensibly rotating out of those funds, and into passive ETFs. As that trend continues, and I see no indication of it slowing down at all, one can only expect that correlations between different stocks will continue to rise. And as correlations rise, of course, it becomes increasingly difficult to justify an active strategy.

ICI chief economist Brian Reid says that “considering historical investor patterns for the last 20 years, we are currently seeing weaker investor demand for domestic equity mutual funds than those patterns would lead us to expect.” Too right we are. And there ain’t gonna be no mean-reversion, either. That $3 trillion is going to end up reallocated, sooner or later. And if your business model is based on managing domestic mutual funds and getting a steady flow of new investments, you’re not going to find life easy going forwards.


Mr. Salmon,

The overall AUM at Dimensional as of June 30, 2010 was over $160 billion. This can be verified at its public website: http://www.dfaus.com

All of the equities included in that amount are invested in a passive manner.

Dimensional is an institutional-only investment firm and did not break out the amount of the overall number above that was invested in non-US assets on its public access website (i.e., the $97 billion). However, you should be able to verify it by contacting Dimensional.

However, I do need to make one correction in my earlier post. While none of Dimensional’s offerings are ETFs, it does provide its investments in vehicles other than “mutual funds.” For example, I believe it offers collective trusts and mutual-fund-like-vehicles in other countries. The main point I was trying to make was that none of these investments are structured as ETFs.

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Bad idea of the day: copyrighting cocktails

Felix Salmon
Aug 31, 2010 17:32 UTC

I wonder whether Chantal Martineau stopped to think about her timing, as she wrote her piece for the Atlantic on a movement pushing for the ability to copyright cocktails. Intellectual-property protection isn’t getting great press this week, as Paul Allen has turned overnight into one of the world’s most gruesome patent trolls.

But ever since the seven-year-old sitting next to you in elementary school put his arm around his paper to stop you from copying his work, humans have felt very protective of their ideas, and very angry at anybody who they think might be copying them. As a result, mixologists are now joining fashion designers in looking for copyright protection for their inventions.

It’s all very silly, not least because the last thing the world needs is bartenders suing each other over copying cocktails. Even Susan Scafidi, the person mostly responsible for pushing the ability to copyright fashion design, realizes that copyright is a pretty narrow and limited protection, and that we shouldn’t try to apply it willy-nilly to anything remotely creative. Here’s what she told me back in 2007, telling critics to look at “legal and social realities”:

Furniture is protected by design patents (overall shape), copyright (surface designs), and trademark — not to mention utility patents (innovative useful elements). One lawyer who represents a number of furniture clients described the process of protecting their designs to me as “triage,” identifying what needs to be protected and sending it to the appropriate government office. Cuisine has a small amount of protection from copyright (recipe collections), and much more from the social norms against copying among creative chefs, particularly when it comes to signature dishes. Since my father is a serious amateur magician (and I confess to having performed a bit myself years ago), magic tricks are my favorite inapposite example. Not only is the literature copyrighted, but many effects are deliberately kept secret by magicians, and unlike fashion can’t be torn apart at the seams by interlopers …

Every industry is unique, and most copyright protection is one-size-fits-all.

Cocktails are clearly closer to recipes — in fact they are recipes — than they are to the kind of things which are normally copyrighted, like books. What’s more, they don’t scale. Fashion designers can sell the same design at many shops and to many different customers around the world, just as publishers can sell the same book through thousands of different outlets. But a bartender can only make cocktails one at a time, and there’s no way that I’m depriving a bartender in DC of any revenue if I order one of her cocktails from a bar in New York. As a result, anybody trying to prove damages is going to face an uphill task.

The fact is that the current cocktail renaissance is coming about because, rather than despite, the fact that cocktail recipes are easily shared and remixed, and because the rise of blogs is making doing so easier than ever, helping drive a surge in demand for well-made, well-mixed drinks.

Mixologists like Eben Freeman who want copyright protection seem to me a bit like the small neighborhood coffee shops who got scared when a Starbucks opened up across the street — only to find that demand for their own good coffee went up, rather than down, as a result. The more people copy your cocktail, the more demand there will be for your cocktail, and the happier everybody will be. Embrace it, don’t fight it.


How is this any different than when Moe stole The Flaming Homer?

Marge: So, Mr. Hutz, does my husband have a case?

Hutz: I’m sorry, Mrs. Simpson, but you can’t copyright a drink.

Homer: [whines] Oh!

Hutz: This all goes back to the Frank Wallbanger case of ’78. How about that! I looked something up! These books behind me don’t just make the office look good, they’re filled with useful legal tidbits just like that!

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Can the Fed’s helicopter drop money on Treasury?

Felix Salmon
Aug 31, 2010 16:25 UTC

Ricardo Caballero has an interesting idea:

The economy is barely muddling through. While some of this is unavoidable given the magnitude of the financial shock that is slowly working its way out of the system, macro-policy still has an important role to play in preventing a relapse. Unfortunately, the Federal Reserve has the resources but not the instruments, while the US Treasury has the policy instruments but not the resources. It stands to reason that what we need is a transfer from the Fed to the Treasury.

Caballero doesn’t give an indication of how big this transfer should be. But presumably he thinks the transfer should be substantially larger than the sums that the Fed is already remitting to Treasury.

And remittances are pretty large, and they’ve been growing sharply since the Fed started expanding its balance sheet. Remittances from the Fed to Treasury ranged from $19 billion to $34 billion between fiscal 2000 and fiscal 2008. In fiscal 2009, they were $34 billion — that’s the amount of money the Fed sent to Treasury between October 2008 and November 2009, about $2.8 billion a month. But if you look at calendar 2009, the Fed ended up remitting $46 billion to Treasury — that’s a rate of $3.8 billion a month. And in fiscal 2010, the CBO projects that total remittances will reach a whopping $77 billion — that’s $6.4 billion a month.

(The historical CBO data comes from this CBO report; the projections come from this one.)

The CBO, back in January, took the Fed at its word and projected that remittances would start falling after fiscal 2010, to $74 billion in fiscal 2011, $52 billion in fiscal 2012, and a low point of $41 billion in fiscal 2013 before they started rising again. But remittances are largely a function of the size of the Fed’s balance sheet, and given that the Fed is dipping back into its QE arsenal, the chances are they’ll be higher than that in actuality.

Put it all together, and the present value of the Fed’s remittances to Treasury is surely well over $1 trillion. I’m sure there’s some way that the Fed could front-load its remittances, paying out a few hundred billion dollars now, and paying less in future. That way Treasury wouldn’t need to “commit to transfer resources back to the Fed once the economy returns to full employment”, as Caballero suggests — it would just get lower remittances going forwards.

Treasury would still need to spend that money, though, and I do wonder whether it might need some kind of Congressional approval to do so. Anybody care to weigh in on the constitutional implications of this idea?


Is there any limit to how much U.S. treasury securities the fed can purchase?

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Sorkin, Dealbook, and linking out

Felix Salmon
Aug 31, 2010 14:01 UTC

On Friday, Dan Loeb released his second-quarter investor letter, which was immediately published by Dealbreaker. It’s a very political document, kicking off with a full page of quotations from various presidents (and, for some reason, Chinese general Liu Yazhou). It’s easy to see why Andrew Ross Sorkin uses it as the jumping-off point for his column today, headlined “Why Wall St Is Deserting Obama.” And as ever, the column is reposted at Sorkin’s Dealbook blog.

Now Sorkin and Dealbook are the exemplars, at the NYT, when it comes to the journalistic virtue of putting primary documents online. Their Scribd account has over 100,000 subscribers and has had over 2 million visits; it’s much more active than the parallel documents.nytimes.com format used by much of the rest of the paper.

But anybody reading Sorkin’s column today simply has to take him at his word when he says that Loeb’s letter “sounded as if he were preparing to join Glenn Beck in Washington over the weekend.”

If I wanted, I could paint I different picture of the letter. I could point out that there are no fewer than three quotes from Barack Obama on its first page, talking about the importance of helping others and spreading wealth across the whole American population. I could note that Loeb is just as harsh on capitalists as he is on the government.

Many people see the collapse of the sub-prime markets, along with the failure and subsequent rescue of many banks, as failures of capitalism rather than a result of a vile stew of inept management, unaccountable boards of directors, and overmatched regulators not just asleep, but comatose, at the proverbial switch.

And he also sees new government rules being helpful on this front:

Many of the boards we have come across are populated by individuals who rely on the stipends they receive from numerous corporate boards and thus appear motivated primarily to ensure continuing board fees, first-class air travel and accommodations, and a steady diet of free corned beef sandwiches until they reach their mandatory retirement age. We are therefore encouraged by the recently finalized proxy rules, which will ease the nomination and election of directors by shareholders.

He’s even pulling with the government when it comes to cracking down on sleazy for-profit colleges:

Our perspective on the government’s increased willingness to use its regulatory muscle enhanced our short positions in the for-profit education space. Indeed, this summer certain government actions taken regarding these companies served to accelerate the unfolding of our thesis on these names.

So, who has the more accurate view of Loeb’s letter, me or Sorkin? The answer is Sorkin: I’ve been quoting very selectively. But in one crucial respect I’m being much more open and transparent about the letter than he is: I’m linking to it. He’s not.

There’s no legal or journalistic reason why Sorkin shouldn’t link prominently to the letter. When I spoke to Richard Samson, the NYT’s top lawyer on such matters, he was clear that although there are copyright reasons why the NYT might not post the letter itself, there’s absolutely nothing to stop the paper from linking to where the letter is posted elsewhere. And in general, Sorkin’s Dealbook blog is pretty good when it comes to external links.

I see a few possible reasons why Sorkin might not link to the letter, none of them good.

First, he might be moving Dealbook away from the blog concept (and it was always more of an email newsletter than a blog to begin with) to something much more self-contained. Dealbook has been hiring aggressively, and is clearly setting itself up in opposition to, and in competition with, other online sources of financial news. Maybe that makes Sorkin more hesitant to link out than he was in the past.

Alternatively, maybe Sorkin is happy to link out in theory, but he has problems linking specifically to the relatively juvenile and tabloid Dealbreaker. I don’t think that’s true: Dealbook does link to Deabreaker on a semi-regular basis.

There’s a couple of other possibilities, too, which are more worrying. Perhaps Sorkin got the letter directly from Loeb himself, on the condition that he not publish it, and he felt that linking to it would violate the spirit of that agreement. Or maybe there was no formal agreement at all, but Sorkin just felt that linking to the letter would annoy Loeb, and therefore decided not to do so in order to help maintain his relations with a source.

Or maybe it was just an oversight, further evidence that linking to primary sources simply isn’t very important at the NYT.

My hope, as Dealbook beefs up, is that it’s going to become more, rather than less, bloggish — that it’s going to spend as much effort on aggregating and curating news and information from around the web as it is on breaking that news itself. Indeed, one would expect Dealbook to have linked to Loeb’s letter before Sorkin’s column appeared.

Of course, the coming NYT paywall is going to make such bloggishness difficult, but difficult need not mean impossible. Let’s hope Sorkin hasn’t given up on many of the possibilities of the online medium before he’s even really got going.


Felix Salmon
Aug 31, 2010 03:43 UTC

An Impressive New Feature Makes Gmail’s Inbox Smarter — GigaOm

Wherein a billionaire does enormous real-estate deals without having a clue what he’s doing — Curbed

Susanne Craig leaving WSJ for the NYT — CJR

My lesson from reading Amy Wallace on libel suits: make sure that, unlike Simon Singh, you’re US-based — Reporting on Health

The number of vacant houses in the U.S. is now roughly 2x the entire Canadian housing stock — Kedrosky

Very excited about the MFAA’s upcoming El Anatsui show, in its shiny new space — MFAA

For the first time since at least 1997, less than 29% of stock ratings worldwide are “buys” — Bloomberg

“The majority of students committed to earlier deadlines, resulting in higher grades” — Ariely

The “efficient relationship paradox”: a company’s current customers experience its worst service — TNY

55% employees say workers wearing casual attire are more productive. But 64% say managers should dress up — Plan Sponsor

Federal Taxation of Labour Income in Canada is Regressive: A truly excellent blog post — Worthwhile Canadian Initiative

A Question for the Kansas City Fed — Economist’s View

“One-bedrooms, which measure about 1,000 square feet, will cost $10,000 a month” — NYT

44% would pick being richer, 21% thinner, 14% smarter, 12% younger. 9% would stay the same — NYP

I haven’t laughed so much reading a blog entry in ages — Language Log


oops, sorry for the double post

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How increased immigration would help fix the economy

Felix Salmon
Aug 30, 2010 21:32 UTC

Never mind the stimulus vs austerity debate: here’s something that both sides should be able to get behind. It’s a simple legislative fix which increases tax revenues without raising taxes; which increases the demand for housing; which increases the economy’s productive capacity; and which boosts wages for American workers. It’s about as Pareto-optimal as legislation gets. So let’s open the borders, and encourage much more immigration into the US!

The SF Fed’s Giovanni Peri has the latest research on the subject:

Statistical analysis of state-level data shows that immigrants expand the economy’s productive capacity by stimulating investment and promoting specialization. This produces efficiency gains and boosts income per worker. At the same time, evidence is scant that immigrants diminish the employment opportunities of U.S.-born workers.

The effects of immigration on US wages are large, positive, and significant:

Over the long run, a net inflow of immigrants equal to 1% of employment increases income per worker by 0.6% to 0.9%. This implies that total immigration to the United States from 1990 to 2007 was associated with a 6.6% to 9.9% increase in real income per worker. That equals an increase of about $5,100 in the yearly income of the average U.S. worker in constant 2005 dollars. Such a gain equals 20% to 25% of the total real increase in average yearly income per worker registered in the United States between 1990 and 2007.

It’ll be interesting to see how much debate this paper receives. Anti-immigration forces are more likely to ignore it than attack it, I think, if they don’t like what it says. And George Borjas seems to have stopped blogging over a year ago, which is a shame, because he would be the perfect foil for Peri.

Is there any chance of significantly liberalizing America’s immigration regime? I doubt it, not while unemployment is over 9%. No matter how convinced economists are that immigration creates jobs, voters aren’t going to believe them. And so politicians aren’t going to vote for it. Talk about ignoring the low-hanging fruit.

Update: Cardiff Garcia provides background here.


Immigration – at current or at increased levels – does not increase wages of low-wage (esp minimum wage) workers and harms them by driving up the rents they must pay in an environment where there is already a severe shortage of affordable rental housing for low-wage workers.

Immigration IS good for homeowners but bad for renters and especially for low-income renters who pay too much for housing.

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Frannie’s juristic parasites

Felix Salmon
Aug 30, 2010 20:51 UTC

Everybody knows that the biggest winners from default and foreclosure are always the lawyers. But did you know that default fees on foreclosed properties alone are now being racked up at a rate of $2 billion a year? That’s the kind of money which attracts a lot of interest:

In the past five years, many of the default industry’s largest law firms have leveraged their mushrooming volume — courtesy of their status with the GSEs — into private equity investments, not to mention a large cash payday for their firm’s partners. Unlike many other areas of law, foreclosure processing typically involves a significant amount of paper pushing, and many law firms have set up operating subsidiaries to their legal operations to manage this aspect of their businesses. It’s these paper-pushing subsidiaries that have been purchased by private equity and hedge fund investors in recent years, looking to find a profitable investment during the economic downturn.

The interesting thing about this market is that it has sprung up in the shadow of Fannie and Freddie, which are being very strict about what is and isn’t allowed in this market:

Beyond determining the legal fee schedule for much of the multi-billion dollar default services market, the GSEs also largely determine who gets their own foreclosure work. Both Fannie and Freddie maintain networks of law firms called “designated counsel” or “approved counsel” in key states marked with significant foreclosure volume — and they either strongly suggest or require that any servicers managing a Fannie or Freddie loan in foreclosure refer any needed legal work to their approved legal counsel.

Each state will have numerous designated counsel — sometimes as many as five law firms — but in practice, attorneys say, two to three firms end up with the lion’s share of each state’s foreclosure work. In states hit hard by the housing downturn and foreclosure surge, like Florida, the amount of work can be substantial…

Freddie Mac sent out a memorandum last week to its designated counsel stating that its law firms could not agree to a blanket cut in foreclosure and bankruptcy fees involving Freddie Mac loans without the GSE’s approval first…

“It won’t be long until we have a federally-regulated foreclosure industry, where Congress sets allowable fees,” opined one of the attorneys I spoke with.

I can see the attraction, from Frannie’s point of view, of keeping the foreclosure business in a small number of foreclosure mills which behave in a predictable and affordable manner. If they’re going to do that, however, they should have strict oversight over those law firms, some of which look very sleazy indeed. Federal regulation, in this context, doesn’t look like such a bad thing at all. Because you can be quite sure that those private equity and hedge fund investors have no particular interest in being scrupulously fair when foreclosing on a delinquent borrower.

Litton, Goldman’s id

Felix Salmon
Aug 30, 2010 18:31 UTC

The apple, it seems, doesn’t fall far from the tree:

Litton Loan Servicing received more consumer complaints than any other loan servicer in the three years through June 2010, according to the Better Business Bureau. The 794 complaints against Goldman Sachs’ Litton led Morgan Stanley’s Saxon Mortgage at 631 complaints, American Home Mortgage at 597, Ocwen at 521 and Barclay’s HomEq at 161. The BBB gave Chase, Litton and Ocwen “F” grades due to the volume of complaints filed, their failure to respond and the seriousness of many complaints. Facing a BBB investigation in 2005 prompted by excessive complaints, the BBB voted to revoke Litton’s membership, but Litton promptly resigned. “They were arrogant,” said Dan Parsons, president of the BBB’s Houston chapter. “It was all about how much money they could make.”

I’m sure that Goldman has often regretted buying Litton, but I also get the feeling that it’s kind of their painting in the attic — the place where the dark Goldman id gets its fullest and most honest expression. Lloyd Blankfein was famously passed over for a job at Goldman before getting a job as a commodities trader at its J Aron subsidiary and rising stratospherically through the ranks; I wonder whether some dark genius at Litton will similarly manage to vault up to become senior Goldman management. After all, subprime mortgage servicing is just about the only part of the financial markets which is even more arrogant than commodities trading.


This was very helpful. I need to learn more about law. I am very new to it. Thanks for all the tips!

William | http://www.leenandemery.com

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Why official statistics are like corporate earnings

Felix Salmon
Aug 30, 2010 17:24 UTC

Mark Gimein uncovers some statistical legerdemain at the Harlem Village Academies, a pair of middle schools in New York. Let’s see how good you are at middle school math, by seeing whether you can answer this question correctly.

A middle school runs from 5th grade to 8th grade. In the 2006-7 year, it had 66 students in its fifth-grade class. In the 2009-10 year, 100% of its eighth-graders were proficient in math. If all the eighth-graders who passed their math test were members of the fifth grade in 2006-7, how many eighth-graders passed their math test this year?

If you said 66, you get an F. If you said “I don’t know, probably a few of those fifth-graders moved away, maybe 60?” you get a D. If you said 19, you get an A.

Of course, the public announcements from the Academies are all about that 100% math-proficiency rate, and make no mention of the fact that clearly you’re only allowed to even enter eighth grade in the first place if you’re going to pass that test.

Gimein puts his finger on the broader syndrome:

Steve Koss, a former math teacher at Manhattan’s Lab School, paints the city’s relationship with stats as an example of Campbell’s Law at work. Named for sociologist Donald T. Campbell, the precept holds, essentially, that the more that numbers are used for political purposes, the more they will be manipulated—and distort the decisions they were supposed to inform.

So whenever you see a politician citing some datapoint you never much heard about before, be very suspicious. And the same goes double when money’s on the line: if inflation-linked or GDP-linked bonds ever become a large part of a government’s liabilities, expect shenanigans surrounding the official inflation and GDP figures. Statistics can be useful, but only if nobody much cares about them. In that sense, they’re a bit like headline corporate earnings.


I think your question is a bait-and-switch also. You asked “…how many eighth-graders passed their math test this year?” The answer is 100%, as stated earlier; 100% were proficient. What you were trying to ask, and either didn’t state cleary or intentionally fuzzed the question, is how many of the fifth graders in the 2006-2007 class passed the 8th grade math test. That answer we can’t determine without knowing transfer/dropout rates.

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