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Why Index Funds Are Like Subprime CDOs

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Re: Why Index Funds Are Like Subprime CDOs

#211

Post by fountainofage »

neilk wrote: post #38
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…

I’m know I’m a dummy when it comes to economics, and an investor in index funds because of that. But it strikes me that index funds are parasitical in a way and depend on price signals from active investors. Some people say that it’s ok, the situation is self-correcting. But what if the smart active money is active in places we can’t see in the public markets? Again, I’m a dummy, but I believe a lot of investment is…

Private investment is absolutely where the money is these days. Look at how the media claims an IPO that doesn't pop 30% or more on day one is a "failure." No one who actually contributed to that company's value benefits from that pop, and best case scenario is really to either have the IPO be flat or even go down a little. But those elite that buy their way to the front of the line demand to have that 30% pop for contributing nothing.

I'll just point out there's the argument about market makers and underwriting and blah blah blah. If that's such an issue just price that into the underwriter fees to begin with. No reason the public markets should lose out on a 30% gain to people that didn't actually take a risk and invest early in the company, and only intend to hold the stock for 8 hours at most.

Re: Why Index Funds Are Like Subprime CDOs

#212

Post by Narkov »

candiodari wrote: post #188
ptero wrote: post #158

Earlier quoted context omitted.

It could be more serious than the flash crash (again, just an interpretation). Flash crash gets resolved quickly and is transparent to non-participants because there is a lot of money willing to buy on dips. But fast trading money only buys and sells what they perceive to be highly liquid assets -- there are few things that scare them more than being stuck with an open trade. The scenario Burry describes is akin to C…

The fundamental reason this happens is that Index Funds aren't "real" stocks. You cannot really sell SPY. There is a bucket of shares owned by SPY. Those contain shares of the index' companies. There's an "owned by clients" bucket and there's a "share liquidity reserve" bucket (with shares of companies in the fund). There's also a (small) liquidity "bucket of cash". And of course, that company can, subject only to it…

The market has built-in circuit breakers or collars to stop wholesale panic selling. It's basically a pause so everyone can stop and come to their senses.

https://www.cnbc.com/2015/08/24/when-do-circuit-breakers-kic...

Re: Why Index Funds Are Like Subprime CDOs

#213

Post by mtanski »

swsieber wrote: post #208
edmundsauto wrote: post #163

Earlier quoted context omitted.

Is your suggestion that overproduction of housing is what caused the bubble?

I could see overproduction of housing as a sign of the bubble. E.g. why are we suddenly giving out more loans?

New large generation (Millenials) coming to the housing market. Low interest rates driving folks to refinance. New housing is flat YoY if you look at "House Starts" statistics.

Re: Why Index Funds Are Like Subprime CDOs

#214

Post by freewilly1040 »

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…

But as an index fund investor isn't the dollar amount invested in those tiny market cap companies quite small? It's unclear to me if the cumulative effect of liquidity problems for the stocks of those companies would be enough to make a sizable dent in an index fund portfolio of someone not looking to panic sell.

Re: Why Index Funds Are Like Subprime CDOs

#215

Post by thoughtstheseus »

bcit-cst wrote: post #195
ptero wrote: post #140

Earlier quoted context omitted.

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…

One thing I am trying to understand . lets say there is a super flash crash and take Acme INC Day 1: (before crash) price : 200$ S&P 500 weight : 2% Day 2 :next day market crashes. Acme is very low volume so price crashes to 1$ . what happens next ? do all the EFT that follow S&P have to sell all ACME for 1$ because it is not in the S&P 500 anymore. Day 5 : ACME jump back to 200 $ and is back in the S&P 500. So my qu…

Index changes don’t happen like that and a drop that large would freeze trading.

Re: Why Index Funds Are Like Subprime CDOs

#216

Post by freewilly1040 »

throw0101a wrote: post #189
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 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 evidence shows that most of us suck at investing. Further, I think Burry's critique is more limited: > One reason he likes small-cap value stocks: they tend to be under-represented in passive funds. IMHO, the problem he's stating is that people are focusing on large-cap…

He's saying index funds are invested in companies big enough to be indexed, but too small for the stocks to remain liquid in a market with a lot of sellers.

By this reasoning indexes focussing on small caps would be even worse than the more popular funds.

Re: Why Index Funds Are Like Subprime CDOs

#217

Post by freewilly1040 »

blankaccount wrote: post #74
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 article is claiming that index funds are an overhyped bubble, so of course they'll out perform actively managed funds that have better liquidity.

Index funds aren't CDO's though, they are quite well established and their outperformance of active management goes back decades (IIUC).

Re: Why Index Funds Are Like Subprime CDOs

#218

Post by holdenc »

bcit-cst wrote: post #195
ptero wrote: post #140

Earlier quoted context omitted.

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…

One thing I am trying to understand . lets say there is a super flash crash and take Acme INC Day 1: (before crash) price : 200$ S&P 500 weight : 2% Day 2 :next day market crashes. Acme is very low volume so price crashes to 1$ . what happens next ? do all the EFT that follow S&P have to sell all ACME for 1$ because it is not in the S&P 500 anymore. Day 5 : ACME jump back to 200 $ and is back in the S&P 500. So my qu…

The S&P reconstitutes itself four times a year. But, imagine that your scenario worked anyways -- the investor would have less than $1000 since the S&P index missed the recovery of Acme Inc. But considering the largest constituent of the S&P (MSFT) is only around 4% of the index total weight, the impact of Acme Inc's price decline would not be great.

Re: Why Index Funds Are Like Subprime CDOs

#219

Post by cbanek »

fragsworth wrote: post #155
dcolkitt wrote: post #59

Earlier quoted context omitted.

The thing is even if Burry is right (and that's a big if), it doesn't mean that you as an individual investor with a long time-horizon should do anything different. Burry's argument is that many of the underlying stocks inside the index have a lot less liquidity than the index funds and securities themselves. E.g. if a lot of capital quickly exits the index funds, then some of the single-name stocks may be overwhelme…

> If some stock falls 50% because of panic selling, without anything having to do with the underlying company, it will eventually return to the correct price. And much sooner than the decades long timeline that you're saving for. But that's not true, because suppose if 99.9% of investors are buying ETFs and only 0.1% are actively managing, there won't be enough funds to bring all these panic dislocated stocks back up…

> But that's not true, because suppose if 99.9% of investors are buying ETFs and only 0.1% are actively managing, there won't be enough funds to bring all these panic dislocated stocks back up for many, many years.

The price change of a stock doesn't always depend on how often a stock is bought. For example, when earnings hit, a stock can easily move 10%. That's not because there was a certain amount of people buying at every price between what it was and +10%. This can happen because earnings are better, and many people base price of an earnings multiple. When new knowledge is put into the system, there's a new price.

If everyone who is trading a stock agrees on a price, that is the price. If people don't agree, it is generally the highest price someone is willing to sell it for (and find a buyer), or the lowest someone is willing to buy it for (and find a seller). If that disconnects a lot, you get a high bid/ask spread, and possibly no shares trade (lack of liquidity). It might only take a few shares or be a very short time to move a stock a lot.

Re: Why Index Funds Are Like Subprime CDOs

#220

Post by sriram_sun »

graeme wrote: post #96

Index funds definitely have a free rider problem. Warren Buffett lucidly pointed out that the average performance of active investors will be....the market average. You cannot, by definition, have a majority of investors beating the market. And once you add in fees, index funds produce above average performance, as they have low fees. So far so good. But, the index funds are free riding on the decisions taken by acti…

> But, the index funds are free riding on the decisions taken by active investors.

I'm sure there is a pretty clear criteria for making it to the S&P 500 or the Nasdaq 100. Which means it can be coded up. Index funds don't track the investments of other active investors. They track the performance of companies (typically market leaders) based on some transparent and objective criteria. These performances could be tied to a multitude of factors - Founder managed, innovative, market focus, sales & marketing, slave labor, good copycats who knows (or cares?). The point is they've made it to the top of some list and are generating revenue within a system of "acceptable" checks and balances. If the company doesn't meet that criteria, it will be booted off of that list. The bet is always focused on objective criteria. None of that is free riding on active traders.

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