Why Index Funds Are Like Subprime CDOs • Hacker News Board

Re: Why Index Funds Are Like Subprime CDOs

#271

Post by anm89 » Thu, Sep 05, 2019, 5:23 AM UTC

The fervor with which people advocate for ETFs is creepy to me.

Ive noticed so many situations where people from all walks of life who don't seem to have put too much thought into the details of how financial markets work, get deeply offended at the idea that the whole world can't collectively park their money in ETFs and collect an absolutely guaranteed 4-7% until the heat death of the universe as if it was some fundamental law of nature.

It's not just that they disagree, it's that you seem to be attacking some part of their identity by the mere suggestion.

Re: Why Index Funds Are Like Subprime CDOs

#272

Post by graeme » Thu, Sep 05, 2019, 5:36 AM UTC

sriram_sun wrote: post #220

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 tie…

This is not correct. According to wikipedia, the s and p (for example) has eight criteria:

market capitalization, liquidity, domicile, public float, sector classification, financial viability, and length of time publicly traded and stock exchange.

Market cap and liquidity are determined entirely by active traders.

Domicile, public float and sector classification are more negative criteria than positives. They exclude a company from the index for not meeting them, but by themselves are not reason for inclusion. Many american companies meet them.

The same applies to length of time traded.

That leaves only one criterion, financial viability.

Meanwhile, the purpose of the index is to track the performance of the 500 largest companies. That's market cap, determined entirely by the price of shares outstanding multiplied by their number.

Re: Why Index Funds Are Like Subprime CDOs

#273

Post by nabla9 » Thu, Sep 05, 2019, 5:37 AM UTC

Nothing in the article or in the linked articles, indicates that he is talking about physically replicated passive index funds that replicate few times a year. He is not giving any explanations that would fit to these normal index funds.

Ignoring small-cap stocks is kind of side show, because massive index funds can't make much return from small-cap stocks anyway. Even if you create index that includes them, they add only a little ROI.

I don't see how index funds can remove price discovery, because they always follow price signals from actively managed funds.

There may be market bubble and too much money caching profits but unless actively managed funds start outperforming index funds, they are not doing anything worth investing.

Re: Why Index Funds Are Like Subprime CDOs

#274

Post by leon1717 » Thu, Sep 05, 2019, 5:41 AM UTC

It wouldn't hurt his reputation throwing such opinions. After bashing down index, he suggested everyone should take a look at some small caps in Japan. That wouldn't hurt either. The point of investing in index is because it saves our time and energy to try to become excellent investors(just maybe). He's selling something, obviously, he's not even trying to lay opinions.

Re: Why Index Funds Are Like Subprime CDOs

#275

Post by leon1717 » Thu, Sep 05, 2019, 5:50 AM UTC

And of course, he's reading in a lot of feedbacks of his opinions right now. He wins anyway.

Re: Why Index Funds Are Like Subprime CDOs

#276

Post by kd5bjo » Thu, Sep 05, 2019, 5:57 AM UTC

human20190310 wrote: post #182

colechristensen wrote: post #178

Earlier quoted context omitted.

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 correlate…

> put [your money] into individual companies you understand and believe have long term profitability If anyone was able to do this, they'd be a successful money manager themselves. Yet few professionals actually manage to do this at all, let alone sufficiently to justify their fees, which is why index-fund investing is so popular in the first place. The only real way to reduce the reliance on index funds is for profe…

There’s a lot more that goes into the success of a business than the financials that investment services firms have access to. It’s entirely possible for someone that interacts with a company on a daily or weekly basis to have a better idea of how well that business is doing than professional investors, especially if they also bother to look at the public financials.

Gathering this kind of information may be too labor-intensive to justify doing it as a profession but rewarding enough for an interested amateur.

Re: Why Index Funds Are Like Subprime CDOs

#277

Post by sriram_sun » Thu, Sep 05, 2019, 5:59 AM UTC

graeme wrote: post #272

sriram_sun wrote: post #220

Earlier quoted context omitted.

> 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 tie…

This is not correct. According to wikipedia, the s and p (for example) has eight criteria: market capitalization, liquidity, domicile, public float, sector classification, financial viability, and length of time publicly traded and stock exchange. Market cap and liquidity are determined entirely by active traders. Domicile, public float and sector classification are more negative criteria than positives. They exclude…

Ok. Thanks I see your point. Active traders set current market value. So if the price of AAPL goes to $1MM, then the indexes adjust accordingly. Cool!

Re: Why Index Funds Are Like Subprime CDOs

#278

Post by kd5bjo » Thu, Sep 05, 2019, 6:13 AM UTC

edmundsauto wrote: post #201

gizmo686 wrote: post #170

Earlier quoted context omitted.

What do you mean by "general consensus"? If you mean "current market values", then those are being set by the aggragate opinions of active traders. If there are less active traders, there is less brainpower being devoted to finding this consensus, so it would be suprising if the consensus did not get less accurate.

Isn't the price set by everyone, not just the active traders? It's set each time a sale happens, but the price itself is also related to how many people are holding the stock long term. I don't really consider it possible for pricing to be "accurate". It is what it is, but accurate implies there's a correct valuation, which I don't think there is.

For financial products, there is a correct price but it cannot be known for certain until far in the future. Stocks in particular represent a claim on the future dividends of the company, whether issued during operation or at the dissolution of the company. If both those future dividends and future inflation were known, you could accurately calculate the present value of that cash flow and get the correct price.

Re: Why Index Funds Are Like Subprime CDOs

#279

Post by dllthomas » Thu, Sep 05, 2019, 6:17 AM UTC

He seems to use volume traded as a proxy for depth of the market. Is that well supported? I could imagine a stable stock moving no volume because the price didn't move, while everyone is lined up eagerly to make trades an increment out on either side of the current price.

Re: Why Index Funds Are Like Subprime CDOs

#280

Post by robocat » Thu, Sep 05, 2019, 6:20 AM UTC

thekyle wrote: post #264

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…

> 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 I'd like to point out that while this may be the case for traditional mutual funds, it is not for ETFs. ETFs don't redeem shares for cash they redeem them for equities in the underlying index. So ETFs don't actually buy or sell any securities unless they rebalance.

That depends on:

A) the standard lock-up period of a fund, or

B) an ETF under strong selling pressure can be halted by the exchange. Some contracts presumably allow an ETF manager to halt sales if high outflows and low liquidity? Certainly can occur with funds.