A critique of the claim that passive investing is a bubble • Hacker News Board

Re: A critique of the claim that passive investing is a bubble

#91

Post by navigatesol » Thu, Sep 05, 2019, 5:12 PM UTC

talolard wrote: post #2

I think this article really misses the point that Burry was making, which is that if the indexs see a sell off they won't find the liquidity in the market to cash out their positions and will drive the market down. This article seems to focus on all of the upsides of indexing, which are all true. However, those upsides don't negate the risk that is being pointed to.

>* if the indexs see a sell off they won't find the liquidity in the market to cash out their positions and will drive the market down.*

What is unique about no liquidity during a sell-off driving markets down? It's the definition of a sell-off. The fact there's no liquidity is what drives down the market in every sell-off.

Re: A critique of the claim that passive investing is a bubble

#92

Post by dcolkitt » Thu, Sep 05, 2019, 5:13 PM UTC

mrep wrote: post #11

talolard wrote: post #2

I think this article really misses the point that Burry was making, which is that if the indexs see a sell off they won't find the liquidity in the market to cash out their positions and will drive the market down. This article seems to focus on all of the upsides of indexing, which are all true. However, those upsides don't negate the risk that is being pointed to.

How would they lose liquidity? 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 al…

Burry's point wasn't that the ETFs would lose liquidity, but rather than the lightly-traded names in the index would.

If the index instruments have a lot more liquidity than the underlying names, then that means they won't be able to gracefully absorb the liquidity shocks from an unwind in the index.

Here's some back of the envelope calculations. Between SPY, IVV, and VOO alone, there's $500 billion in S&P 500 index ETFs. Consider if an unwind event leads to 20% of index assets being redeemed in a single day. That's $100 billion from the above ETFs alone.

Now consider a typical thinly traded single-name stock like Chubb Limited (symbol CB). CB makes up 0.3% of the S&P 500 by weight. So in the hypothetical scenario above, the APs would have to collectively sell $300 million worth of CB in a single day. Chubb's entire ADV is only $238 million.

Trying to sell more than 100% of a stock's ADV in a single day is guaranteed to produce huge market impact. The current liquidity providers in CB almost certainly cannot absorb that amount of trading volume all in one direction. In that scenario, Chubb's stock might fall by 20%, for something that had nothing to do with the company itself.

I think the overall point is that a lot of single-name stocks nowadays don't really have much of an individual market. Names like TSLA, FB or TEVA definitely have a robust market with a lot of traders still focused on company specifics. But a lot of the more boring, lower volatility, mid-cap stocks (like CB) mostly just trade along with the index nowadays. If there are technicals related to index capital flows, stocks like that are going to get taken for a ride.

[1] https://www.etf.com/channels/sp-500-etfs [2] https://www.slickcharts.com/sp500 [3] https://finance.yahoo.com/quote/CB?p=CB

Re: A critique of the claim that passive investing is a bubble

#93

Post by AlanYx » Thu, Sep 05, 2019, 5:16 PM UTC

One question I have about Burry's comments that isn't (directly) addressed in this article relates to Burry's observation that trading volumes are remarkably low relative to the value of assets pegged to the equities being traded. For example, he remarks that over half of the S&P 500 stocks trade under $150 million daily, despite trillions of dollars in assets globally indexed to those stocks. (And he notes that almost half of Russel 2000 stocks trade at less than $1 million during the day.)

My question is, does this imply that there's substantially more synthetic indexing (without ownership of the underlying securities) than we realize? If there are trillions in indexed assets where the funds owned the majority of the index components, wouldn't average daily inflows lead to higher trading volumes than we're seeing? Or are the market makers such a huge portion of the market that they act as a massive collective buffer causing very few shares to actually be traded?

Re: A critique of the claim that passive investing is a bubble

#94

Post by navigatesol » Thu, Sep 05, 2019, 5:20 PM UTC

dcolkitt wrote: post #64

sambe wrote: post #22

Earlier quoted context omitted.

These sections seem to address the point to me: * "The tail is not wagging the dog" - index funds are a relatively small percentage of total share ownership. * "Benchmark huggers have always been around" - owning ~the index was not started with index funds. * "Active funds literally own the market" - the sum of portfolios of non-index funds ends up having the same profile. * "Price discovery is a cop-out" - relativel…

> "Liquidity is not a huge problem for index funds" -no market impact to sell (v dubious if you ask me), unlevered. If you're talking about index mutual funds, then the author is just plain wrong. Any open-ended fund offering daily liquidity will trade, and therefore produce market impact, to meet its daily redemptions. If you're only talking about ETFs, then this is technically correct. Besides the occasional index…

>If a flurry of investors rush to enter or exit an ETF, then a huge amount of trading has to be done to create or redeem the shares. Just because the APs create this trading impact, instead of the fund itself, is a distinction without a difference. The underlying stocks in the index are subject to market impact.

But the trading isn't the cause of the market impact, it's the redemptions that occur first, and force the trading. There had to have been economic or financial reasons for those redemptions to occur. The fact that when everyone tries to sell at one, there's aren't enough buyers is a story of the ages. That ETFs will suffer the same consequences in a run is hardly unique to them as financial assets.

Re: A critique of the claim that passive investing is a bubble

#95

Post by prostoalex » Thu, Sep 05, 2019, 5:20 PM UTC

mrep wrote: post #11

talolard wrote: post #2

I think this article really misses the point that Burry was making, which is that if the indexs see a sell off they won't find the liquidity in the market to cash out their positions and will drive the market down. This article seems to focus on all of the upsides of indexing, which are all true. However, those upsides don't negate the risk that is being pointed to.

How would they lose liquidity? 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 al…

> Even if one of the underlying stocks becomes illiquid

Burry’s money quote in the original Bloomberg article was on limited liquidity for a largish number of stocks - over a 1,000 stocks in Russell 2,000 weren’t traded heavily (by his benchmark).

Re: A critique of the claim that passive investing is a bubble

#96

Post by bradshaw1965 » Thu, Sep 05, 2019, 5:21 PM UTC

talolard wrote: post #2

I think this article really misses the point that Burry was making, which is that if the indexs see a sell off they won't find the liquidity in the market to cash out their positions and will drive the market down. This article seems to focus on all of the upsides of indexing, which are all true. However, those upsides don't negate the risk that is being pointed to.

It's important to distinguish market cap based indexes and other asset class indexes. Small and micro-caps are notoriously hard to trade but mega-caps typically have much higher liquidity. There is a much higher chance of a micro-cap passive fund having a liquidity problem then a market cap index fund.

Re: A critique of the claim that passive investing is a bubble

#97

Post by ptero » Thu, Sep 05, 2019, 5:21 PM UTC

sharkbot wrote: post #9

talolard wrote: post #2

I think this article really misses the point that Burry was making, which is that if the indexs see a sell off they won't find the liquidity in the market to cash out their positions and will drive the market down. This article seems to focus on all of the upsides of indexing, which are all true. However, those upsides don't negate the risk that is being pointed to.

Not the author, but I think the article indirectly talks about the liquidity in the markets being far higher than it has been in the past. Further, if there is a stampede for the exits, there still have to be buyers on the other side of the sellers. Those buyers will undoubtably include active managers along with those indexers with different time horizons and/or braver constitutions. Both will likely be rewarded for…

> if there is a stampede for the exits, there still have to be buyers on the other side of the sellers

That is a key point in the debate. I do not see that above is necessarily true. Say a price of a low volume stock X is driven down below fundamentals just because index funds have to sell 1% of holdings and cannot find enough buyers for X. While price of X might be irrational fund managers might not be able to act on it because there would be a worry that it may go lower still if selling extends.

Could next round get X removed from index? delisted? "The market can stay irrational longer than you can stay solvent" is not an empty worry. My 2c.

Re: A critique of the claim that passive investing is a bubble

#98

Post by navigatesol » Thu, Sep 05, 2019, 5:23 PM UTC

bwanab wrote: post #39

sambe wrote: post #22

Earlier quoted context omitted.

These sections seem to address the point to me: * "The tail is not wagging the dog" - index funds are a relatively small percentage of total share ownership. * "Benchmark huggers have always been around" - owning ~the index was not started with index funds. * "Active funds literally own the market" - the sum of portfolios of non-index funds ends up having the same profile. * "Price discovery is a cop-out" - relativel…

Right, but consider that the sub-prime mortgage market was a tiny portion of the overall mortgage market in 2007. Derivatives written against sub-prime holdings tipped the balance when the fan was hit. There are tons of derivatives written against the indices, thus indirectly against those funds.

>Derivatives written against sub-prime holdings tipped the balance when the fan was hit

There's a bit more nuance to it: those derivatives were a problem because a substantial proportion of them were concentrated in a single, widely-connected, entity (AIG).

The derivative market as a whole nets to zero; for every loser there is a winner.

Re: A critique of the claim that passive investing is a bubble

#99

Post by hogFeast » Thu, Sep 05, 2019, 5:24 PM UTC

thanatropism wrote: post #62

hogFeast wrote: post #55

The "this time is different" crowd rides again. Burry highlighted two simple truths of financial markets: people will buy shit they don't understand, and people who make financial products will try to earn a liquidity premium by transforming something illiquid to something liquid (which always blows up). Most people (who I have met) who own passives have no idea what they are buying but are sure that buying passives…

I hate this kind of smart-ass top-level "ITT" comment that paints an entire discussion happening besides it with broad strokes. If only one person does this I can call him names and downvote him. If there are two camps and both camps do this, people tribalize and everything goes meta. Then no further actual discussion can take place.

If you think it is "smart-ass", you don't understand what I am saying (or, more probably, what Burry is saying).

There are no "camps" here. The OP is trying to create a tribe (passive investors are cultish, so this is a very odd comment...I will assume an honest mistake) but that makes no sense on this topic (unless you are selling something, which he is).

The meta of my point is: people try this discussion over and over, it is always wrong, some things in finance are universal (because they have been happening for literally three hundred years).

What you appear to have missed is the part where I said: Burry is not making a "bombastic claim" about what will happen 100% of the time. In my experience, most people think this is what investing is about (the OP is certainly an example). It isn't. I am not making a bombastic claim.

The observation is, again, that: you have a lot of unsophisticated buyers and some non-zero amount of these products are about liquidity transformation. You can have a debate about this all you want but it isn't interesting or engaging to anyone but people who are unsophisticated (not 100% true in this case, Asness is a notable exception but he was an academic and it is mostly academics who take an interest).

My interest is limited to the fact that: it is astonishing how often this happens, and equally astonishing how fervently people will deny that it is happening again (although they are usually new converts).

Re: A critique of the claim that passive investing is a bubble

#100

Post by Raidion » Thu, Sep 05, 2019, 5:25 PM UTC

dcolkitt wrote: post #92

mrep wrote: post #11

Earlier quoted context omitted.

How would they lose liquidity? 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 al…

Burry's point wasn't that the ETFs would lose liquidity, but rather than the lightly-traded names in the index would. If the index instruments have a lot more liquidity than the underlying names, then that means they won't be able to gracefully absorb the liquidity shocks from an unwind in the index. Here's some back of the envelope calculations. Between SPY, IVV, and VOO alone, there's $500 billion in S&P 500 index…

This is a really good explanation, but you would think market forces would kick in. If a company drops 20% (or even 3%!) from an event that doesn't effect the business itself, you're going to get smart money buying. I'd have a hard time believing some niche hedge fund somewhere wouldn't make a killing off this by providing liquidity.

This is under the assumption that there will be capital available to flow, if there isn't because of a truly bad scenario, yes it's a downward spiral, but it will take quite an event to get us to that point.