Could you explain how this would work in practice? If I'm allocating a percentage of my salary to, for example, Vanguard's total stock market index, how would that get siphoned?

One simplified example: say people are investing in a passive property fund. Those funds generally yield around 3 to 5% per year.

You're a smart entrepreneur. You build a huge skyscraper for $200m. You manage to generate a yield of 10% on that $200m. Most of the $200m is debt levered against the asset. The building subsequently gets sold to the fund on a yield basis. They'll pay $400m, i.e. $20m in yield p/a = 5%.

Smart entrepreneur just made $200m.

Smart entrepreneur had to take massive risks (albeit short term because of the sold yield) and do a ton of work over the timespan it takes to have that come to fruition.

Yes, I understand the reward is also super high. I'm just trying to point out that for most people if they tried this they'd likely fail to pull it off(competence) or run out of runway(contingency).

Just pointing out how you can siphon off massive amounts of money from passive investors because they invest in a certain fixed way. Smart entrepreneur (he's smart after all) would also likely raise his capital from a wealthy family office, thus take very few risks himself.

Private equity roll-ups are another example -- you buy one amazing asset at 15x earnings, roll up a few other ok or "meh" businesses that you can buy at 5 to 10x earnings, and go public with a group that then trades at 20x earnings. Preferably while loading it up with a ton of debt before going public. Who buys that? Why your pension fund, of course.

The p/e is basically irrelevant. You want to buy a company that is somehow broken (hence why p/e is irrelevant - if the company was barely losing money, the p/e would be infinite).

Buying a broken company allows you to fix the flaw(s), and then sell the fixed company back to the market. Even if the p/e were the same, if done correctly, you make a killing on the deal.

I think you’re partially correct, but you’re missing out on the asymmetry of the risk/reward payoff. People often forget that there is a lower bound to losses (zero), but no upper bound on price (and therefore profit).

Also, most of these bets that have super high payoffs are initially made when others were walking away from similar bets. There’s significant research to support this, too.

Also, everyone can’t build a $200mm skyscraper, there are limits to how many of those we need.

Typical passive investing vehicles are float-adjusted. That means your analogy is inapt to something like a Total Stock Market fund.

If everyone is just doing passive investment, there's no real price discovery, it's just valuable companies getting more valuable just because they're already valuable. It also screws with management incentives for the companies when their 'owners' are completely checked out and uninterested in performance.

Vanguard is hardly a passive owner: https://about.vanguard.com/investment-stewardship/policies-a...

Essentially toothless because an index fund is going to invest the money either way.

False! SNAP has been explicitly excluded from the S&P500 index for exactly this reason[0]. I'm not sure if "whole market" passive funds would include it or not. At the very least VTI has 0.03% of assets in SNAP[1]. Not much to worry about.

0 - https://uk.reuters.com/article/us-snap-s-p-idUKKBN1AH2RV

1 - https://www.etfchannel.com/symbol/snap/

You’re confusing the maintainer of the index’s ( Standard & Poors) with the implementation (Vanguard).

If S&P puts a company in, Vanguard will buy the shares. Not doing so could cause problems, including lawsuits.

Yes, and as I said the S&P500 index excludes companies like Snapchat with the founder-has-most-votes trick. I suppose the real issue here is how much money goes into which indices, and which ones exclude companies like these.