The thing with predictions in the market is, even if you're the guy who figured out subprime before everyone else, your probability of getting it right the second time is completely independent of the last time.
Why Index Funds Are Like Subprime CDOs
251–260 of 324 posts
Re: Why Index Funds Are Like Subprime CDOs
#252Earlier 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…
Burry's point is not that a lot of indexed stocks are relatively illiquid and thus index funds would have a hard time getting out of them in a serious downturn. His point is that the index funds don't own the stocks at all; they trade derivatives like futures and CDO's that mimic the movement of the stocks in leveraged fashion, and the more people who dump their money into index funds without doing their own research…
IWM, the largest of the Russel 2K ETFs with $38B cap has exactly 0.14% in cash/derivatives ($53.7M)
https://www.ishares.com/us/products/239710/ishares-russell-2...
Re: Why Index Funds Are Like Subprime CDOs
#253Earlier quoted context omitted.
"Potentially making it worse will be the impossibility of unwinding the derivatives and naked buy/sell strategies used to help so many of these funds pseudo-match flows and prices each and every day. This fundamental concept is the same one that resulted in the market meltdowns in 2008."
The keyword there is "help". They use derivatives to handle the daily fund flows. They should be a tiny percentage of the whole fund value.
Burry's point is, whatever the percentage of leverage, it's reaching levels that are dangerous for the larger economy.
Re: Why Index Funds Are Like Subprime CDOs
#254Earlier 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…
My understanding is that the largest index funds use free-float weighting. This adjusts the weight of a stock in the index by the proportion of the stock that trades freely in the market. https://en.wikipedia.org/wiki/Capitalization-weighted_index#...
In the example you give, this should result in Berkshire Hathaway Class A to have a very small weight in an index fund weighted this way.
Looking at the holdings of VOO, as of July 31, 2019, It holds 806 shares of Berkshire Hathaway (Class A) (worth ~$249 million), but about 37 million shares of Class B, worth ~$7.6 billion.
https://investor.vanguard.com/etf/profile/portfolio/VOO/port...
Re: Why Index Funds Are Like Subprime CDOs
#255Earlier quoted context omitted.
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.
I think the fund managers know this and will collude to prevent it from happening. They are smart enough to know about game theory, it's not their money. So they can sit and not go on a selling frenzy.
Re: Why Index Funds Are Like Subprime CDOs
#256Earlier 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…
Burry's point is not that a lot of indexed stocks are relatively illiquid and thus index funds would have a hard time getting out of them in a serious downturn. His point is that the index funds don't own the stocks at all; they trade derivatives like futures and CDO's that mimic the movement of the stocks in leveraged fashion, and the more people who dump their money into index funds without doing their own research…
> His point is that the index funds don't own the stocks at all
This is misleading, I think. Depends on the fund. Some seek to match the benchmark through a certain exposure to derivatives and synthetic things. Others hold the stocks in proportion.
The vanguard funds I'm invested in don't have much synthetics - they own the stocks
Re: Why Index Funds Are Like Subprime CDOs
#257Earlier quoted context omitted.
Index changes don’t happen like that and a drop that large would freeze trading.
There is no market rule that prevents a single stock from dropping 99% in a day. LULD only halts trading for a few minutes, then there's an auction that could result in any price.
There is no market rule that requires a single stock from not being halted.
Please show me a one day 99% drop on a stock. Trading would be halted well before that to prevent manipulation or errors.
Re: Why Index Funds Are Like Subprime CDOs
#258Earlier quoted context omitted.
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...
Sounds good in theory, and I think that's more for automated trading. In practice if real people panic and are selling, no circuit breaker will stop it, each break will just build up massive pressure and every time it's removed, will result in more drop. If the market is frozen for a long time, all trust will be eroded since it will be seen as pure market manipulation which is what it is.
Re: Why Index Funds Are Like Subprime CDOs
#259Earlier quoted context omitted.
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 worke…
> After all, when there's a market crash, did millions of machines in factories fall apart...
In 2008, the crash happened because suddenly Wyle E. Coyote realized there was gravity when he ran off the cliff. Mortgages were actually defaulting on a very high rate, but people put blindfolds on and didn't want to see. It wasn't just a "psychological overreaction" but real fear and panic as those same investors were trying to squeeze through the same exit door as everyone else.
There is still some reasonable fear in 2019 that large financial institutions will choose to make money at the expense of the economy.
Re: Why Index Funds Are Like Subprime CDOs
#260Earlier quoted context omitted.
There is no market rule that prevents a single stock from dropping 99% in a day. LULD only halts trading for a few minutes, then there's an auction that could result in any price.
There is no market rule that requires a single stock from not being halted. Please show me a one day 99% drop on a stock. Trading would be halted well before that to prevent manipulation or errors.
The rules are covered here: https://www.sec.gov/oiea/investor-alerts-bulletins/investor-...
LULD is the one that applies to single stocks. It only results in a five minute halt, as I said.
The market-wide circuit breaker can halt the entire market for a full day, but only in response to a 20% move in S&P500, not a single stock.