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Strategies & Market Trends : Waiting for the big Kahuna -- Ignore unavailable to you. Want to Upgrade?

To: IceShark who wrote (26500)	9/4/1998 1:23:00 PM
From: Oeconomicus	Read Replies (1) \| Respond to of 94695

IS, I was thinking about all those market-on-close orders the other day when CNBC was interviewing the manager of a new Dow index fund. As they are supposed to be 100% invested all the time, they must invest all the money that comes in the door on a given day. As they are "passive" investors, buying the close and possibly paying too much does not matter to them (the new money gets fund shares priced at the close anyway). The interesting thing, though, is that liquidations of index funds could magnify downward closing moves. If they have net outflows on a given day, they MUST sell as they have no cash to meet redemptions and, just as buys, they are likely to happen at or near the close. It's a theory, anyway. Thoughts? BTW, I have another theory about index funds that may get tested soon if we are in a bear market. Much of the money in index funds is there because managed funds have generally underperformed the indexes. As more money came into the funds, that they would outperform became a self fulfilling prophecy. The more they outperformed, the more money that came their way, resulting in even more demand for stocks in the indexes. The effect goes doubly for the largest caps in the capitalization weighted indexes like S&P - as money comes in, most of it goes to the largest few stocks, pushing them up and increasing their weighting (these are also the relative few stocks program traders would use as a proxy for the index rather than buying or selling all 100 or 500 stocks). My theory is that, with an extended period of net redemptions (beyond just a week or two) of index funds (which can't just reduce cash to meet redemptions and have no choice about what to sell), those funds, the underlying indexes and the largest cap stocks would tend to underperform managed funds and small caps. The experts seem to be at a loss to explain the failure of small caps to catch up with the major indexes, but I think index funds and passive investing are the biggest reason. If I am right and if this bear hangs around for a while to cause index fund redemptions, the small caps' day in the sun may be around the corner (relative performance, of course). Just a theory. Bob