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Why Index Funds Are Like Subprime CDOs

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Re: Why Index Funds Are Like Subprime CDOs

#171

Post by davvolun »

shalmanese wrote: post #148
drelihan wrote: post #127

Earlier quoted context omitted.

Imagine there was a cookie market made up of two types of cookies, tasty and meh. An active investor in cookies would spend time determining which cookies are likely tasty and which are meh. They would pay more for the tastier cookies so they can savor the flavor and less for the meh ones they can binge eat in the shower when no one is home.... A passive investor comes along and says, I don't want to do all this rese…

At the limit of 100% passive, everyone agrees the system would break down. But that’s not a realistic endpoint. There are studies to suggest that as little as 1% active is enough to keep the markets functioning and we’re nowhere near that point.

Of course at 1%, or really, any sufficiently small and centralized number, it becomes easier and easier to game the system...

I'm thinking specifically of attempts to artificially inflate crypto coin valuations for members, then quickly sell off before anyone catches on. Should be, I would think, impossible to do that across a large area of the market, but if everyone is investing in index funds, it might be, I would guess.

Nonetheless, for my situation, index funds are the best rational solution. That or hiding all my money under my mattress.

Re: Why Index Funds Are Like Subprime CDOs

#172

Post by lukewrites »

piker wrote: post #83
lukewrites wrote: post #7

The discussion of this on the Bogleheads forums, a community dedicated to low-cost investing primarily via indexing, provides an interesting counter-point to Burry's opinions: https://www.bogleheads.org/forum/viewtopic.php?f=10&t=289284

> a community dedicated to low-cost investing primarily via indexing Right or wrong, that must be one boring place. [Re: downvotes, The post was just intended to convey that the thesis of "put your money in the lowest cost index funds using an allocation formulatically dictated by modern portfolio theory, and don't touch it for the next 35 years" would be unlikely to provide much fresh content.]

You would think so, but I've been surprised at the diversity of topics on there. There's especially good stuff for folks who are interested in some of the ideas of people like William Bernstein[0], who advocate for index-based portfolios that are more complicated than the bog standard two- or three-fund ones.

[0] https://www.bogleheads.org/wiki/William_Bernstein

Re: Why Index Funds Are Like Subprime CDOs

#173

Post by lukewrites »

0xcafecafe wrote: post #54
lukewrites wrote: post #7

The discussion of this on the Bogleheads forums, a community dedicated to low-cost investing primarily via indexing, provides an interesting counter-point to Burry's opinions: https://www.bogleheads.org/forum/viewtopic.php?f=10&t=289284

This is a good point: Post by ltlurker » Thu Aug 29, 2019 1:24 pm I'm an index investor, like most Bogleheads, and I subscribe to Bloomberg digital so I can read articles such as this and did see this one at lunch (EDT). I'm open to various perspectives especially if there appears to be a rationale behind them. And of course this individual was behind the "big short" so that intrigued me. If I recall correctly, I bel…

Not sure if it's mentioned in that thread yet or not (I've been meaning to post it), but Jack Bogle himself said the markets would start to get weird if 75%+ of investments were indexing:

https://www.marketwatch.com/story/john-bogle-has-a-warning-f...

Re: Why Index Funds Are Like Subprime CDOs

#174

Post by OrangeMango »

ptero wrote: post #140
markbnj wrote: post #58

Not knowledgeable on these matters, so my money is in index funds. Obviously a lot of other people are in the same category as myself. The article seems to be saying we'd all be better financial citizens if we put our money into actively managed funds, or did our own investing. The latter is out of reach for most people, and with respect to the former it's somewhat puzzling that managed funds can't consistently outpe…

I will try to interpret, but obviously it is just my interpretation (and personally I mostly agree with many theses Burry gave). First, he does not really talk about being a "good citizen" or not. His points are for "greedy citizens" who, in his view, should be worried (about his pocketbook) if he is heavily invested in passive index funds. This is due to his "bigger and bigger crowds, same exits" analogy: individual…

> What happens if there is a small, but synchronized outflow for any reason? If customers ask for 1% of index funds to be sold, index funds have to sell 1% of their holdings in the exact ratios defined by the index

That's pretty interesting.

In 2019, the average daily trading volume of Berkshire Hathaway (class A) was 0.04% of the total shares outstanding. If all people that held this stock were forced to sell 1% of the total shares outstanding, look out!

On the other hand, Roku has averaged 15.6% this year, with a standard deviation of 10. 1% of total shares isn't even going to be noticed.

Re: Why Index Funds Are Like Subprime CDOs

#175

Post by WorldMaker »

randogogogo wrote: post #117
blankaccount wrote: post #100

Earlier quoted context omitted.

I agree, I saw below in someone else's comment that the issue is with the attitude of "[index] stocks will always go up in the long term", which is similar to the attitude "house prices always go up in the long term" which caused the 2008 crash.

This short explanation put the reasoning behind this in the best context for me, but makes me wonder more about the dissimilarities. Are there other factors like in the housing market of a decade+ ago? Is there a lot of risk for Joe Six-Pack? Are there people out there borrowing money from banks with poor underwriting practices getting into index funds when they should not be doing so? I'd think if this is most peopl…

A lot of 401k providers have been pushing passive Index funds as "stable" late-life investments with higher return rates than actually stable securities such as bonds. So maybe there is a fear to find there that there is a lot more short term thinking and short-term investors in Index funds than there "should be" (and that market adjustment there could be disastrous to a lot of retirees).

Re: Why Index Funds Are Like Subprime CDOs

#176

Post by kds3 »

whatshisface wrote: post #53
groundlogic wrote: post #3

Not an economist, but it's obvious to anyone used to thinking in terms of systems that index funds can't work after a certain amount of the money poured into the system is managed by index funds. What's the limit - 30% 40%, 50%, 60%? What's the current level in terms of managed capital? (Edit: https://www.cnbc.com/2019/03/19/passive-investing-now-contro... says 45% for US stock-based funds, half a year ago, so maybe…

> but it's obvious to anyone used to thinking in terms of systems that index funds can't work after a certain amount of the money poured into the system is managed by index funds. If you have one trillion dollars invested, and the entire exchange volume is based on me and my friend trading a single share back and forth, everything will still work. It doesn't matter how much you own, because my friend and I are going…

> entire exchange volume is based on me and my friend trading a single share back and forth, everything will still work

You are talking like such a market is extremely liquid (there are enough shares for everyone). I think when a third person enters such a market your example breaks apart. Now you have one person who constantly wants to buy a stock but is unable to do so. Because you and your friend trade at a fair price and index fund does nothing. So he have to buy at an unfair price and rises his bid until index funds kicks in the game.

Re: Why Index Funds Are Like Subprime CDOs

#178

Post by colechristensen »

markbnj wrote: post #58

Not knowledgeable on these matters, so my money is in index funds. Obviously a lot of other people are in the same category as myself. The article seems to be saying we'd all be better financial citizens if we put our money into actively managed funds, or did our own investing. The latter is out of reach for most people, and with respect to the former it's somewhat puzzling that managed funds can't consistently outpe…

The market is in peril because there are too few actors setting value based on the merits of the company instead of betting on other investors' behavior.

You want to help? Pull some, not all but some assets out of index funds and put them into individual companies you understand and believe have long term profitability. Sell those assets when you think they're overvalued by the market.

Trading less often is correlated with better performance (you are not an HFT)

There is some responsibility you have. Your money isn't going to just magically work for you, you have some obligation to research and understand what you are investing in. When nobody does it, the market is in trouble.

Re: Why Index Funds Are Like Subprime CDOs

#179

Post by charwalker »

markbnj wrote: post #58

Not knowledgeable on these matters, so my money is in index funds. Obviously a lot of other people are in the same category as myself. The article seems to be saying we'd all be better financial citizens if we put our money into actively managed funds, or did our own investing. The latter is out of reach for most people, and with respect to the former it's somewhat puzzling that managed funds can't consistently outpe…

There is an interesting idea when index funds are taken to an extreme in that if no one is manually playing the market or managing investments then everything is invested in at the same or similar rates. Index funds need active traders to trade and set pricing within the market.

My analogy would be if we are all buying tickets to the big game and sit in the stands until it's over, there's no one to yell and shout and drive the energy of the crown or possibly no one to even compete on the field therefore why are we even showing up?

It's definitely the extreme - active trading isn't going away any time soon but fears of a only a limited group playing the market and managing or controlling stock prices for their gain isn't 100% unrealistic.

Re: Why Index Funds Are Like Subprime CDOs

#180

Post by jcfrei »

whatok wrote: post #87
pwthornton wrote: post #46

Isn't a big part of the issue with actively managed funds the fees, which usually wipe out any gains above index funds. Wouldn't the market correction be to close the delta in fees between active and passively managed funds to encourage more people to go the active route? A lot of the grousing about passively managed funds come from people who are running actively managed funds that charge huge fees to under perform…

You can't run most active management strategies on anything approaching the average passive fee structure. Additionally, you run into problems with scale. An S&P 500 tracking fund scales extremely well and could add several billion of AUM without having to incur additional expenses. A long only equity fund would probably not be able to do the same without hiring more people, building more infrastructure, etc.

Lots of active funds just change the weights of their capital allocation a bit compared to their benchmark. So there's not necessarily more people or infrastructure required - just analyzing a few companies in more detail.
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