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Why Index Funds Are Like Subprime CDOs

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Re: Why Index Funds Are Like Subprime CDOs

#221

Post by mcguire »

The only part that I find interesting or possibly worrying:

"Liquidity Risk

"“The dirty secret of passive index funds -- whether open-end, closed-end, or ETF -- is the distribution of daily dollar value traded among the securities within the indexes they mimic.

"“In the Russell 2000 Index, for instance, the vast majority of stocks are lower volume, lower value-traded stocks. Today I counted 1,049 stocks that traded less than $5 million in value during the day. That is over half, and almost half of those -- 456 stocks -- traded less than $1 million during the day. Yet through indexation and passive investing, hundreds of billions are linked to stocks like this. The S&P 500 is no different -- the index contains the world’s largest stocks, but still, 266 stocks -- over half -- traded under $150 million today. That sounds like a lot, but trillions of dollars in assets globally are indexed to these stocks. The theater keeps getting more crowded, but the exit door is the same as it always was. All this gets worse as you get into even less liquid equity and bond markets globally.”"

But other than that the market in index funds dwarfs that in the indexed securities, I haven't the vaguest clue what they (this isn't the first time I have heard this) are worried about.

Re: Why Index Funds Are Like Subprime CDOs

#222

Post by aledalgrande »

WorldMaker wrote: post #175
randogogogo wrote: post #117

Earlier quoted context omitted.

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).

Even basic investment courses, and any investment guru, will say any stock investment is not low risk enough if you need the money short term.

Re: Why Index Funds Are Like Subprime CDOs

#223

Post by kccqzy »

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…

> 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

How so? I can certainly see "lost opportunities" where good stocks are undervalued just because they aren't in the index funds, but I don't understand why you think index funds can't work. Can you elaborate?

Re: Why Index Funds Are Like Subprime CDOs

#224

Post by mcguire »

OrangeMango wrote: post #174
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…

> 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…

That's an interesting point; it would seem like the stocks Michael Burry, the Big Short investor, likes would be in the same boat.

Or maybe he's counting on their low volume? :-)

Re: Why Index Funds Are Like Subprime CDOs

#225

Post by the_gastropod »

swsieber wrote: post #204
basch wrote: post #115

Earlier quoted context omitted.

A total market index fund is proportioned by market cap. As the large cap gets larger, it proportionally becomes a higher percent of the pie. If large cap is overvalued, youre owning less small cap than "true price market cap."

Ah got it. So I by sharding my investment into several different different targeted funds (with auto-rebalancing) avoid that issue.... I think.

You’re trading one issue for another. By holding x% of a small cap fund, where x does not equal the actual market proportion for small cap funds, you’re choosing to over or under weight that asset class.

Re: Why Index Funds Are Like Subprime CDOs

#226

Post by WorldMaker »

aledalgrande wrote: post #222
WorldMaker wrote: post #175

Earlier quoted context omitted.

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).

Even basic investment courses, and any investment guru, will say any stock investment is not low risk enough if you need the money short term.

Sure, but 401(k)s have nicely~ distributed investment planning across the lowest common denominator worst case on both sides: banks with too much vested interest in cumulative commissions and fees on one side, investors with effectively zero knowledge and a large number of competing (mis)information sources with arguably little opportunity to discern proper advice versus zeitgeist and marketing.

Re: Why Index Funds Are Like Subprime CDOs

#227

Post by mcguire »

Retric wrote: post #205
OrangeMango wrote: post #174

Earlier quoted context omitted.

> 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…

Index funds can and generally should skip Berkshire Hathaway class A and just buy class B stocks without issue. It’s meaningless in this context. The SP500 has a long tail 150M on a 20B dollar company, which is the median, is 0.75% per day that’s quite a bit of motion normally but you expect volatility to go up on a major sell off. Anyway, if 1% of all money is removed from index funds on the same day whatever caused…

If 1% of the money in index funds exited the market in any form (not just index fund withdrawals), it's going to be a bad day any way you look at it.

Re: Why Index Funds Are Like Subprime CDOs

#228

Post by jackcosgrove »

dfabulich wrote: post #184
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…

That doesn't answer markbnj's question. You elaborate why the passive market is in peril (because in the event of a sell-off, the ETFs will be forced to sell a bunch of low-volume stocks, crashing them), but that's just explaining in detail that the market is in peril because not enough money is flowing to people who do a poor job of managing it. But, granting that Burry is right and you're interpreting him correctly…

Dollar cost average purchases of index funds, and slowly draw down your shares in retirement. Maybe rebalance every year or so as you get older. In other words, don't panic or try to time the market. Those are purely speculative and usually pro-cyclic movements that just introduce noise into price discovery. After all, when there's a market crash, did millions of machines in factories fall apart, or millions of workers in offices forget how to do their jobs? It's just a psychological overreaction.

As to institutionalizing this stability, it would be nice if index funds offered fund choices that prohibited selling or trading for one, two, three decades. Since you as the investor would be adding information to the market ("I'm not an index fund band-wagoner, I understand buy-and-hold and I will practice what I preach") you would be rewarded with better returns in exchange for signaling your intentions and acting as a cushion when everyone else is panicking.

Re: Why Index Funds Are Like Subprime CDOs

#229

Post by mcguire »

dfabulich wrote: post #184
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…

That doesn't answer markbnj's question. You elaborate why the passive market is in peril (because in the event of a sell-off, the ETFs will be forced to sell a bunch of low-volume stocks, crashing them), but that's just explaining in detail that the market is in peril because not enough money is flowing to people who do a poor job of managing it. But, granting that Burry is right and you're interpreting him correctly…

Can I sell you a mattress?

Re: Why Index Funds Are Like Subprime CDOs

#230

Post by somberi »

A useful read that provides a counter view to Mr.Burry's:

From The Economist.

(1) http://archive.is/2oco0

and

(2) https://www.economist.com/finance-and-economics/2018/07/05/t... (Unable to archive this)

and

(3) https://www.economist.com/finance-and-economics/2018/02/08/p... (Critical piece to note here is about rebalancing. To quote "Someone who bought all listed American stocks in 1986 and did nothing would by now own less than half the market.")

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