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Why Index Funds Are Like Subprime CDOs

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Re: Why Index Funds Are Like Subprime CDOs

#291

Post by lunchables »

southphillyman wrote: post #139
lunchables wrote: post #47

Earlier quoted context omitted.

Aren't most of those double digit gains just from the market rebounding from the 2008 recession?

Rebound to inflated values? Reminds me of the housing market in my area now. It's "rebounded" to higher than 2008 levels on the basis of speculation and gentrified neighborhoods being hot. Seems like another bubble. I need to do more research, but I'm curious what the long term viability of these index funds are as more and more people gravitate towards them

I was thinking more, rebounded to 2008 levels + inflation?

Re: Why Index Funds Are Like Subprime CDOs

#292

Post by basch »

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.

If, for example, you thought small caps were under valued, and you wanted to tilt small cap, you could keep doing exactly what youre doing, and just add a small investment into small caps on the side. So at Schwab, if you hold Schwab Target 2060 Index Fund (SWYNX) you can tilt by making sure Schwab U.S. Small-Cap ETF (SCHA) is 10% of your portfolio. At the moment, SCHA is 6.8% of SWYNX, so you would need an additional 3.2%. I dont know if you even need autobalancing for something so simple, just fix your allocation every time you make a contribution.

Re: Why Index Funds Are Like Subprime CDOs

#293

Post by beat »

greenshackle2 wrote: post #187
beat wrote: post #95

Earlier quoted context omitted.

A community consisting of people patting each other on the back for being so much more clever than everyone else is rarely boring to the participants. The fact that this explains a majority of self-selecting communities is purely coincidental, of course.

Including Hacker News, no doubt.

NO SHIT.

Re: Why Index Funds Are Like Subprime CDOs

#294

Post by mrep »

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…

I fail to see how that would ever happen. Authorized participants [0] are always in the market for ETFs. If an ETF share price is crashing out of line with the index it tracks, they will step in and buy shares, swap them with the ETF issuer for the shares of the underlying stock in the index, and sell those shares for an arbitrage profit.

Even if one of the underlying stocks becomes illiquid, a big enough price divergence on all of the other liquid stocks would make it profitable to eat the loss or hold the illiquid ones (risky, but remember, there are many authorized participants competing with each other so if there is some way to make an easy arbitrage profit, they will find a way). You'd basically need the entire market to become illiquid.

[0]: https://www.investopedia.com/terms/a/authorizedparticipant.a...

Re: Why Index Funds Are Like Subprime CDOs

#295

Post by mrep »

mherdeg wrote: post #244
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…

Yeah I think the consensus is that 100% passive would be terrible. Jack Bogle's view was that if the market is 50%+ passive indexed that would be bad news. Some folks argue that the number is even more extreme, that passive indexing generally increases efficiency, and that as long as there are even a handful of active investors, the market will still be efficient: http://www.philosophicaleconomics.com/2016/05/passive…

> Jack Bogle's view was that if the market is 50%+ passive indexed that would be bad news.

According to this source, it already is [0]. HN discussion at the time [1].

[0]: https://qz.com/1623418/index-funds-now-account-for-half-the-...

[1]: https://news.ycombinator.com/item?id=20020997

Re: Why Index Funds Are Like Subprime CDOs

#296

Post by lonelappde »

bb88 wrote: post #259
jackcosgrove wrote: post #228

Earlier quoted context omitted.

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 tryi…

If you were invested in the broader market, and didn't move your whole portfolio in our out of cash in 1 year,the 2008 worldwide economic collapse was barely a blip in long term performance.

Re: Why Index Funds Are Like Subprime CDOs

#297

Post by jldugger »

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…

> What's the limit - 30% 40%, 50%, 60%?

I'd wager at least 90 percent. Passive investing is generally designed to track active investor activity without effort, so it shouldn't add much inertia to the system. If Dave thinks IBM is overvalued and Under Armor is overvalued, the act of buying and selling will shift those numbers, and the index investors, instead of taking the opposite trade and undoing that flow of information, hold their portfolio.

IMO, the real challenge is active investors competing for access to that 10 percent of active invested money. There's no shortage of people happy to manage money under the 'heads I win, tails you lose' fee structure, and one hopes that the same people fighting over a smaller pool of cash would (more strongly than status quo) favor people who can actually produce results.

Re: Why Index Funds Are Like Subprime CDOs

#298

Post by notyourday »

lutorm wrote: post #239
notyourday wrote: post #8

Earlier quoted context omitted.

When people invest money into index funds, then the funds must spend all that money buying the shares of the underlying fund companies . So that creates tons of buy orders for the underlying stocks, which creates the buying pressure, which makes the prices rise. As long as more money comes into the index funds the prices of underlying stocks will keep rising. But the higher the prices of the underlying the more money…

But this doesn't seem to have anything to do with index funds. Wouldn't the same thing happen regardless of the way people are invested into the stock market?

It is directly related to the index funds. They are now marketed as the "correct" way of invest into the market where they in fact invest into a very small number of companies creating an artificial wave of the buy orders.

Actively managed funds have choices in what they invest, and how much they put into any of the companies. Index funds do not.

https://www.etf.com/SPY#overview

for an example.

Re: Why Index Funds Are Like Subprime CDOs

#299

Post by randogogogo »

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).

I guess I'm not old enough to have thought through this already, but it was explained to me early on in my career that 401k plans should be divested slowly as one approaches the end of their career. Is this atypical compared to how it actually works in reality?

Re: Why Index Funds Are Like Subprime CDOs

#300

Post by dougmany »

Terr_ wrote: post #231
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…

"What if everyone became a passive investor" is like worrying "What if the entire ecology became defenseless herbivores?" It just won't happen, because there's a negative feedback loop against it, leading to a kind of homeostasis. > At some point, no one is left to figure out which cookies are tasty vs meh, so the price of all cookies converge to a single price. Five minutes later someone says: "Holy shit, I can make…

Well they will not be able to sell their over priced cookies to the uncaring masses.
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