OhNoNotimAgain wrote:Mkt cap trackers are active users of derivatives. What weight do derivatives have in the index?
None. So don't kid yourselves that mkt cap tracking is entirely passive.
You are overstating your case. It is true that some trackers use derivatives, but many do not and so using that to criticise them all is a little selective.
More generally you will find that the major market trackers, whether open-ended or ETFs, physically hold the underlying components of the index. Derivatives tend to be used for the more marginal products and can make sense in certain situations, such as where it is difficult to hold the underlying, or where the fund is invested in things like commodities where holding the physical doesn't make much sense. Or in exchange-traded notes which are really not funds at all but rather credit obligations.
OhNoNotimAgain wrote:About 3% of the mkt is subject to corporate actions every year so portfolio turnover, even for the least active rules-based fund, is going to be at least 3%. Add in trading to deal with inflows and outflows then any fund with a PTR in low single figures is doing well.
Again, that is very selective. Most of the large providers of trackers run many active funds as well. What this means is that much of their trading can be handled by "internal cross trades". As an example, share X may be sold by a tracker if X drops out of the index, but an active fund from that same provider may be buying X. This means that the trade can be done at an effective cost of zero - the holding isn't really sold but rather internally transferred.
When I worked for a very large fund manager, about 80% to 90% of our trading was via internal crosses.
Finally, I think the active versus passive debate is clouded by the use of those terms. A better distinction, in my view, is between rules-based and manager-based. In the latter case, a manager or committee makes buy and sell decisions based on fundamental and technical analyses of the underlying. For rules-based investing, the role of a manager is diminished or extinguished - once you have defined the rules, the fund runs itself.
Whether that rule is based on a market-cap index or some other rule is not that significant. What ETFs, in particular, allow you is the ability to decide what rules you like and then there is a vehicle for implementing those rules. And it seems that many investors feel more comfortable identifying themes and rules they would like to follow, than poring over balance sheets or trusting those who do. The focus is on an investment idea or belief.