Indexation Is A Socialist Way Of Allocating Capital

Tyler Durden's picture

Authored by Charles Gave of Evergreen Gavekal,

The role of financial markets is to evaluate in real time the marginal return on capital of different assets. This is done through a ‘price discovery mechanism’, with the ‘right price’ found out through a system of constant trial and error. To discover this price calls for a community of active money managers, each doing his or her due diligence before buying and selling. This price is a function of the return on capital and of the expected growth rate of this return. It has nothing at all to do with the size of the investment under consideration. What’s more, if the price of an asset has been going down for the ‘wrong’ reasons, then active money managers should buy more of it. Over time this process will help to stabilize the system.

Active money management is essentially a ‘mean reversion’ strategy. That’s not so for indexation. In the indexation process, there is no attempt at price discovery. The only thing that matters is the relative size of the asset: the bigger the market capitalization, the more an investor should own. This means if the price of a large asset goes up more than the market as a whole, indexers have to buy even more of it.

Thus indexation is a momentum-based strategy. Worse, it is a form of socialism, since new money is allocated not according to the expected return on capital but rather according to the current price of an asset relative to other assets. The bigger an asset, the more one should own…

In a true capitalist system, the rule is the higher the price, the lower the demand. With indexation, the higher the price, the higher the demand. This is insane.

Where it becomes really ridiculous is in the bond markets. Over time, the government bond market of a very badly managed country (like France) will become much bigger than the bond market of a well managed country (like Sweden). As a result, over time indexers have to buy more French bonds than Swedish bonds. The bond vigilantes of yesteryear are now condoning the very crimes they once condemned… and they have no choice about it.

Any economic system based on momentum must be extremely unstable, moving relentlessly from boom to bust and back again, which over time will cause a massive waste of capital. The swings will only be reinforced by zero interest rate policies, since these suppress the cost of capital against which returns on capital should be measured.

The deep thinkers on the New York Times bestseller list all wonder why our economies are moving ex-growth. May I offer a simple explanation?

We cannot have economic growth without a proper cost of capital, nor if capital is allocated, not according to the marginal growth rate of the return on invested capital, but according to the market capitalization of the existing capital stock. What matters is the expected changes in the ROIC and not the current value which the market puts on that return.

Indexation could work if it remained a satellite strategy, with say 10% of the money being managed through indexation, the rest being managed by active money managers. As such, it would be a parasitic strategy. Indexers would benefit from the price discovery work done by others without paying the costs associated with the process.

But a system where everybody wants to be a freeloader cannot work. The real problem here is that investment ‘consultants’ (read failed money managers) have defined risk as a deviation from the index against which the money manager is benchmarked.

This is idiotic. It forces even mean reversion managers to become closet indexers.

Let me be clear: in a properly managed capitalist economy there should only be three returns - in real terms - to worry about:

1) 1%—if one buys 3 month T-bills and does not want to take a duration risk
2) 3%—if one buys long government bonds and is willing to take a duration risk
3) 6%—if one buys shares and accepts the risk one may not get all of one’s money back

Over the long term, equity managers should be measured against the 6% real target. All other benchmarks will lead to the misallocation of capital and create a deeply unstable financial system together with a much lower growth rate and higher unemployment.

In effect, by pursuing indexation we have introduced a socialist way of allocating capital in the heart of the capitalist system.

As we all know, socialism is the ultimate form of freeloading. It has never worked, and it never will. This indexation is one of the most obvious forms of parasitism I have ever encountered.

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Hobbleknee's picture

The heart of what capitalist system? I wasn't aware that capitalism existed anywhere on earth.

Pladizow's picture

Was this authored by a money manager - any bias or self interest here?

What percentage of money mangers beat their bench mark?

Fuck em all - starve the beast!

knukles's picture

Whadda bunch crap for an individual investor who probably (as in 100% probability) does not have the expertise to seek and find significant alpha other than harebrained schemes.

Point #2 .  The vast majority of managers significantly under-perform (as in dollars in dollars out, simple concept) their benchmarks for 2 reasons.
1.) management fees
2.) transactions costs (brokerage bid/ask and fees)

Measuring those two things, most people wind up some 2% behind the index before they blink (As in Malcom Gladwell)

Jesus, people.....


Escrava Isaura's picture

The title "A Socialist Way of Allocating Capital"

Should Read: “I Need Some Capital to Buy a Dictionary”

Democratic koolaid's picture

Math and socialism seem mixed up within this article, alot of mumbojumbo.

Escrava Isaura's picture

Unscramble it is the fun part….

Welcome to democracy 101!


steve2241's picture

Ya pays ya money and ya takes ya chances. 

Urban Redneck's picture

It was authored by a money manager, who (suspiciously) only looked at the bull case, and ignored the bear case, in making an analogy to socialism.

The bear case is actually more damning, because good companies that have created value see that value destroyed and endure higher borrowing costs as collective punishment due to the group think and herd mentality of lazy money managers who can't be bothered to discriminate between good and bad companies to invest in.

An obvious example would be every time dumb money flows out the made-up and very heterogeneous asset class called "Emerging Markets."

Skateboarder's picture

It does, but only select people are allowed to be 'capitalist.' You or I, for example, would go to jail lol.

Death and Gravity's picture

So fucking tired of Amurrcans decrying anything they dislike as "Socialism".

Skateboarder's picture

The memes are engrained so far deep that it's damn near impossible to scrub it off.

flacon's picture

I find that Americans often blame "capitalism" - even calling it "crony capitalism". By contrast I haven't heard people use the term "crony socialism" very often. 

Escrava Isaura's picture

“America’s elites know that capitalism is totally unworkable. We try to impose it in the 3rd world so we can destroy them”

Noam Chomsky

Anusocracy's picture

I don't know what capitalism is or how it works. Therefore, I'll try and impose socialism on the entire world so as to destroy all economies equally.

Noam Chomskytard

Escrava Isaura's picture


Chomsky is more of an anarcho-syndicalist.

It means: Direct action (action undertaken without the intervention of third parties such as politicians, bureaucrats and arbitrators) and direct democracy, or workers' self-management.

Burnbright's picture

No, Noam Chomsky is just a plain vanilla moron. 


What kind of idiot gets to be as old as he is and not realize the contradiction of his logic? He wants to use government to solve social problems when he recognizes that a majority of social problems are in fact created by the government. If only Noam was in charge! He would get it right! /eye roll

Escrava Isaura's picture


It's obvious that you bought into the propaganda of misinformation.

Anyway, the problems humanity faces are of our own making. That's the problems with mammals; they always think they are clever in find solutions.

That’s why all mammals goes extinct every 100 thousand years or so. And we humans are right at this point.

Bendromeda Strain's picture

I almost feel sorry for you dear. Your existence is shrouded in a darkness of your own making. Chomsky won't be able to help... ever.

sessinpo's picture


Escrava Isaura  Anyway, the problems humanity faces are of our own making. That's the problems with mammals; they always think they are clever in find solutions.

That’s why all mammals goes extinct every 100 thousand years or so. And we humans are right at this point.


Bendromeda Strain    almost feel sorry for you dear. Your existence is shrouded in a darkness of your own making. Chomsky won't be able to help... ever.


Escrava Isaura     Do you have a reading comprehension?


My comment. It would appear that you, Escrava Isaura, hase the problem. By your own posts, you admit that you face extinction. That is not reading comprehension failure by Bendromeda. That is total logic failure by you Escrava.

Escrava Isaura's picture


Burnbright said: "social problems are in fact created by the government.

Then, I said: the problems humanity faces are of our own making. (I should have stopped here, so not to confuse the forum). My point: Our social problems are bigger than our governments, because these problems were created by all of us.

Bendromeda Strain then said: “almost feel sorry for you dear. Your existence is shrouded in a darkness of your own making. Chomsky won't be able to help... ever.

My response: "Do you have a reading comprehension?" and it was a poor choice of words, so accept my apologies.

I should have written: “Of course Chomsky would not be able to help, because the issues we will be facing are huge. Catastrophic, in my opinion. The coming financial and energy crisis will be better dealt within your own community.”

sessinpo, I did say that “mammals think that they are clever in find solutions… That’s why all mammals go extinct” and let me explain it in the proper form: I hear lots of solutions been presented here, at Zero Hedge forums. However, many of these solutions will make the problem worse.

I read lots of clichés that distract many of us in find the Aha Aha moment. And that’s too bad. So instead, focus in your community. Start getting to know your neighbors. Start talking to your friends. Organizing.

Those will be proven as the best solutions, because our generation is not going extinct.

However, not sure the next 2/3 generations… Or in case of a nuclear conflict.

Hope that clarifies.

Anusocracy's picture

"However, many of these solutions will make the problem worse."

Should have started with "I believe".

Which is my point: everyone live by their own beliefs and leave all others to their own beliefs. Some beliefs "will be proven as the best solutions".

Unfortunately, too many fools think they are gods.

Twodogs's picture

Those who disagree with you are "misinformed" lol. Your philosophy on mammals was about as insightful as a fence post.

Anusocracy's picture

That he is, and if you are too, I wish for you to live in an anarcho-syndicalist society, while I live in an anarchist society, with both societies having no authority over each over. It's called panarchism.

People have to leave the social structures of the animal world behind and move towards social structures of a human world, structures based on non-aggression, property rights, and voluntary interaction.

Greenskeeper_Carl's picture

that guy, and this isuara person, seem very ignorant of history. Governements cause problems, not fix them. Remember that time everything sucked and then the govt came in and fixed it and everything was awesome? me neither, cuz its never happened. ever.

puckchaser's picture

Cronyism is implied in socialism. 

Escrava Isaura's picture


Cronyism is a byproduct of State Capitalism.

Attitude_Check's picture

In the real-world of Socialism - history says otherwise.  Ask any former citizen of the USSR or Warsaw pact country about cronyism.  Read Belenko in Mig Pilot.

Of course cronyism is definitional in Fascism.  Any time a governmental system is created where a select few have all the power to govern (kingdoms, Dictatorships, Fascism, Socialism), human nature results in cronyism corruption, as the leaders help thier friends.

A decentralized system is what is needed to minimize cronyism, either in government or economics.

Escrava Isaura's picture

Attitude_Check You said: “A decentralized system is what is needed” 

How can you have a decentralized system? Systems are inherited corrupted and damaging.  

How about that: How about having the local population create their own system, say their own cooperatives?

You said: USSR and Socialism.

Attitude, you’re obvious an smart person and I need you to ask yourself this question: By the way, you won’t need to look anywhere for the answer. I will come automatically:

Here’s the question: Do you ever wonder why the US and USSR labeled the USSR as Socialist? In the peak of the Cold-War, how could they have both agreed on something?



Twodogs's picture

Anything that is implemented by force is by definition UNcooperative. How could you miss that?

sessinpo's picture

Escrava Isaura   NO, IT IS NOT.

Cronyism is a byproduct of State Capitalism.


Once again, total logic failure by Escrava. Here is why.

Cronyism is a failure of morality of ANY system. You can have cronyism in any economic system. The question here is how and what system do you have that most quickly addresses such moral failures.

And that becomes difficult because one cannot legislate morality. Thus, after centuries, the answer isn't found yet.



Escrava Isaura's picture




Which economic system has any moral?

Let me go further: Which 'system' of government, religion, or institutions have any moral?

cro·ny·ism: By Merriam Webster Dictionary: noun: The unfair practice by a powerful person (such as a politician) of giving jobs and other favors to friends.

Sessinpo, You said: “because one cannot legislate morality. Thus, after centuries, the (cronyism) answer isn't found yet.”

Wrong! Just ask the people that got nominated as ambassadors.

Two things that don’t go together: Water and Oil. And Humanity and Morality…. I am not so sure about the water and oil.

Twodogs's picture

Well said. Cronyism is the enemy of wealth. It is defined as agreements involving rule changes or discretionary enforcement of such.

Transactional agreements between parties within the rules are not immoral and not wealth destroying, the opposite of cronyism.

Weisshaupt's picture

You don't hear of "Crony Socialism" because cronies are implicit in how the system will be run.  A central Government  Authority confiscates the labor of more productive people  by force  and doles it out as largess to less productive people  ( the cronies)  

In Hypothetical Socialism those in power ensure "fairness" and equal outcomes for all and the govt attempts to care for every citizen as a Shepard would care of his herd. ( Because what is more fair than doing 100% of the work and risk in producing something and getting to keep 10%  as a bunch of other people who contributed litte get thier fair share?)


However, real world socialism invariably fails- due to human nature and how power corrupts.  The  largess collects for the "good of the worker"  is invariably doled out disproportionately to those in power, and those who help keep them in power.  The Pigs ALWAYS move into the farmhouse, and political influence, rather than merit, is what advances one in the society. 

The potential for such corruption is greatly reduced in a  properly functioning Capitalist system with free markets , real price discovery and a limited government that lacks the power to interfere with the markets and individual transactions of individuals.  Its not that real world capitalism will be free of  corruption and fraud  - but the opportunities to centralize power is greatly reduced and  therefore so are the opportunities for theft and graft enabled by the violence of the State . It is only when the State is given such power while still maintaining the illusion of free markets that it becomes "crony capitalism" 


profchaos's picture

I hope we can all agree that index funds are not a feature of socialism.

It seems like the natural evolution of private capital markets is away from picking winners within sectors and toward index funds that capture broader market trends. The faith in active asset management erodes and markets settle down into passive herds driven by momentum and the understanding that the large majority of investors will ride the market up and down together. This is a degenerate mode of capitalism that happens when investors become very far removed from the underlying businesses and won't even pretend to know enough to make informed decisions. I'm just trying to protect my savings. Surely there is someone closer to the boots on the ground who should be judging the merits of particular businesses. Like a commercial bank or something.

There are market economic models in which capital is allocated exclusively via credit unions and/or commercial banks (i.e no stock markets). There are several names for these models but none of them are socialism.

Radical Marijuana's picture

Indeed, Skateboarder, and that may be related to this quote from a link that JR provided below:

p167 "Within the last decade or so, certainly since the 1960s, a steady flow of literature has presented a thesis that the United States is ruled by a self-perpetuating and unelected power elite. Even further, most of these books aver that this elite controls, or at the least heavily influences, all foreign and domestic policy decisions, and that no idea becomes respectable or is published in the United States without the tacit approval, or perhaps lack of disapproval, of this elitist circle."

Since the real world is controlled by lies backed by violence, the biggest bullies' bullshit dominates the language that we end up using. The article above was another example of massive LYING BY OMISSION!

There can be NO "capitalism" not even "crony capitalism" (crapitalism), inside of a system where private banks are legally allowed to make "money" out of nothing as debts. Similarly, it is MEANINGLESS to put forward the label of "socialism" for a system wherein the theoretically public power over the public money supply has become "money" out of nothing as debts, which has been almost totally privatized.

The real world operates according to the principles and methods of organized crime. All other labels for various "isms" or "ocracies" are deliberate bullshit, which most people have been brainwashed to believe in.

The supreme ideology is militarism, the ideology of the murder system, which is the oldest and best developed social science, which is profoundly paradoxical because success depended upon backing up deceits with destruction. Economics was built on top of militarism, in ways which deliberately deny and ignore that as much as possible.

The dictionary definitions of "socialism" or "capitalism" etc., have practically nothing to do with the real world, which is actually dominated by murder and fraud. However, since social success was based on those realities, people use utterly bullshit language, like this article above did.

disabledvet's picture

Yeah, no shit. "Let alone Nationalism."

You gonna pay for that bitch or not?

Sudden Debt's picture

Actually your rigth.
socialisme is a need for society.
A society can be judged by how it handles it's weak. And yes, America is failling bigtime in a psychopathic kind of way.
So socialisme is good BUT it may never grow to big. And that's where the problem lies. We don't want to get rid of it at all, just keep it under control.

Actually, socialisme has nothing to do with the problems. It's government spending and a to big government.
The media just likes to blame socialisme because the government wants nothing more than the people to chip in for a even bigger government.
Know thy enemy, art of war.

And ever since the 70's equality has gone down. Most Americans have no clue what that means but that means, everybody has the same chance to making it. And now, there's about 100 rich ass mother f's who are making sure God only blesses them and that everybody else sneezes.

What we need is a smaal government who is social in behavior but who's not socials and the total distruction of lobbying and backdoors in the taxaction system so every company pays the same kind of taxes and no matter how rich or poor, everybody should also pay the same kind of taxes on a % basis.
No taxes doesn't work like most Americans want because that means the government needs their own income generating companies and than you get into the socialist government type with corruption again.

Matt's picture

Why is it the duty of government to forcebly redistribute wealth to care for the weak?

Why shouldn't caring for others be voluntary?

Leveraged Algorithm's picture

Naive you are - take care of the other to avoid the pitchforks.....

RichardParker's picture

Actually Naive YOU are:


They throw a few crumbs to the lower and lower-middle class in order to pacify them while preventing the upper class from becoming powerful enough to be able to challenge their authority as elected kings.

Sudden Debt's picture

Well, not everybody is as strong.
I'm not saying that those who can take care of themselves should be cared about!
No, I talk about people with handicaps, people who are sick, weak, children. Older people.
But those who can contribute should pull their own weight.

But that's just a European point of view. If your society is different than it's different. For example, i'm not in favor of changing the thinking in Africa either. There the family takes care of the weak.

nmewn's picture

"Actually your rigth. socialisme is a need for society.
A society can be judged by how it handles it's weak."

I think you mean charity and compassion, which you can do & have without being a socialist and delegating those positive virtues to the government because it always leads to...

"So socialisme is good BUT it may never grow to big. And that's where the problem lies. We don't want to get rid of it at all, just keep it under control."

Paraphrasing someone, a government big enough to give you everything you want, is also big enough to take everything you got.


shovelhead's picture

A little bit Socialist is like a little bit pregnant.

nmewn's picture

Yes and a pregnant socialist always gives birth to a bouncing baby communist.

Thats an original by the way ;-)

Bendromeda Strain's picture

Well played, Sir  <golf clap>

UGrev's picture

Smoke another. Socialism is not what we need in any way, shape, or form.  Anything to the left of "leave me the fuck alone" is socialism, fascism or [name your type of oppressive government system here]. That is why people scream socialism when it's not "the American way". Fundamentally, we reject anything that forces people to behave a certain way, and enforces it by way of a gun up our collective asses. We should be a volunteerist society that helps because we are impassioned to do so, not because we are forced to do so at the cost of a potential threat to our own survival. Failure to understand that is nothing short of accepting that people be stolen from by way of force for the good of long as it's not you who is being stolen from. 

Please wake the fuck up already..  

Escrava Isaura's picture

Fascism: Heavily on patriotism and national identity. It exalts nation and race above the individual and stands for severe economic and social regimentation, and forcible suppression of opposition.

Socialism: Workers through cooperatives own all industry. Main aim is to abolish the exploitation of man by man. Public services may be commonly or state owned, such as healthcare and education.