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A critique of the claim that passive investing is a bubble

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

#111

Post by travisoneill1 »

AlanYx wrote: post #93

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 almo…

As the manager of the ETF you could allow it to float freely in which case it could trade at a premium or discount to NAV. But it wouldn't move too far because this would attract arbitrageurs who would trade the ETF against the individual stocks and bring it back in line. This would result in volume in the individual stocks. Another way you could do this is hold a pile of units in reserve and actively sell into the market when the ETF trades at a premium and buy when it trades at a discount. This approach would not result in any volume in the individual stocks (except for re-balancing from time to time). I think what he is saying is that ETF's use the latter approach. Of course this could also be done in an totally synthetic manner, but I don't think that index funds do this. It would be messy.

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

#112

Post by gnicholas »

maerF0x0 wrote: post #74
gnicholas wrote: post #61

> Yes, index investors are free riders, but this is the way most markets work. We don’t go to the grocery store to bid on prices of oranges against one another to set an equilibrium. The market does that for us. Actually, our behavior does shape the price of oranges. If we go to the store and they're less expensive, then we are more likely to buy them. The analogy breaks down because he's comparing indexes and orange…

We bid on a basket of groceries by choosing a store to shop at though. The price of oranges is mostly immaterial when compared to the greater pricing of the collection of goods purchased in a single trip. This is why loss leaders make sense. They entice you in w/ a distorted price and then recoup the loss across your basket.

> * We bid on a basket of groceries by choosing a store to shop at though*

I'm not sure I agree with this. Most grocery stores stock the same food, so it's not as if going to Lucky instead of Safeway shapes what you can/will get. You're right that if you go for particular sale items, you're more likely to get those. But does that have a basket-level impact? I'm not sure it does. Also, consider that when you go to a grocery store, you probably purchase about .05% of the items they sell. It's not like we go to Safeway and buy most of the things they sell there.

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

#113

Post by [deleted] »

Mathnerd314 wrote: post #104
JumpCrisscross wrote: post #34

Earlier quoted context omitted.

> in that case is there a distinction between index funds and actively managed funds? Yes. Active managers can choose what to sell based on prevailing market conditions. Index funds must sell across the board. That could involve getting hosed on names in a short-term squeeze. > this only affects people who are trying to sell at the bottom There are lots of index funds. For a broad-market fund, you're probably right--…

There are some escape clauses in Vanguard's index funds: The fund may temporarily depart from its normal investment policies and strategies when doing so is believed to be in the fund’s best interest. ... Vanguard funds can postpone payment of redemption proceeds for up to seven calendar days. And a lot of index fund investors are buy-and-hold so it's unclear if a recession would even cause a liquidity / redemption c…

[deleted]

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

#114

Post by sokoloff »

AlanYx wrote: post #93

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 almo…

> (And he notes that almost half of Russel 2000 stocks trade at less than $1 million during the day.)

He notes that 456 (a little under a quarter) of the Russell 2000 trade less than $1MM/day: "“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."

S&P index funds have an annual turnover of around 2-4% of AUM typically, so the transaction need to track closely is perhaps not as high as one might think.

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

#115

Post by mox1 »

AlanYx wrote: post #110
Raidion wrote: post #100

Earlier quoted context omitted.

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…

The "smart money" would start buying, but I imagine the concern is that as passive instruments become the majority of the market, there wouldn't be a deep enough pool of assets held by "smart money" to provide offsetting liquidity in the way you describe.

But wouldn't this reach some sort of equilibrium point?

IE if a smart person with a lot of money think there is no "smart money" left, wouldn't (s)he just start their own smart money hedge fund to provide / do this?

If nobody is left to do thing X AND thing X is basically guaranteed profit, isn't it natural for people to step in and do thing X?

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

#116

Post by jeffdavis »

At some point, someone (or a collective) needs to make a decision about how capital is allocated among different firms.

Traditional money managers may not be the right way to do that, but we should be clear that decisions are still being made somehow.

I guess it's not the investors plowing money into the first index fund they find. And it's not the index fund, because they don't do a lot of management.

So I guess it's a handful of hedge funds that set prices?

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

#117

Post by turk73 »

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.

There was the little problem of how sub-prime debt got whitewashed and turned into Aaa rated paper by the ratings agencies. All those sub-prime tranches, had they been correctly rated, would not have had such a magnifying effect. It was because of packaged bonds containing multiple tranches that couldn't be priced at anything but $0. Also, the interest bearing portions of loans were split into different bonds, further complicating matters.

There wasn't (and still isn't) a mark-to-market in bonds. Many bonds aren't priced until bought/sold, e.g. illiquid.

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

#118

Post by SubiculumCode »

AlanYx wrote: post #110
Raidion wrote: post #100

Earlier quoted context omitted.

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…

The "smart money" would start buying, but I imagine the concern is that as passive instruments become the majority of the market, there wouldn't be a deep enough pool of assets held by "smart money" to provide offsetting liquidity in the way you describe.

I know next to nothing about investing, but I thought the article said that passive instruments are a very small portion of the market...and also that in house indexing has always been a thing.

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

#119

Post by Excel_Wizard »

jeffdavis wrote: post #116

At some point, someone (or a collective) needs to make a decision about how capital is allocated among different firms. Traditional money managers may not be the right way to do that, but we should be clear that decisions are still being made somehow. I guess it's not the investors plowing money into the first index fund they find. And it's not the index fund, because they don't do a lot of management. So I guess it'…

Index funds do not contribute to the process of price discovery.

As long as a certain fraction of trades are performed by active investors, price discovery will continue to be accurate. Currently, active traders dominate, making up the majority of trades. This fraction could be much smaller than it currently is and still be OK.

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