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

#121

Post by turk73 » Thu, Sep 05, 2019, 6:00 PM UTC

crb002 wrote: post #43

I don't buy the liquidity argument. Their mere existence creates liquidity. Two sides to every trade. Index fund "sell offs" will likely go to buyers of the same index fund shares but at a lower price. Apple alone has $50 billion in cash that will flow into Vanguard if index funds hit a 50% plunge. Same with Buffet. Index funds may be bubble priced, but they don't suffer from a liquidity issue.

That is only true in a liquid market. I remember plenty of times in 2008 when some stocks went "no bid" and the price plummeted until circuit breakers cut in. Some very blue chip companies got hammered hard back then.

That's the whole concept of why stock traders need to beware the "crowded exit"--if everyone is trying to sell a the same time, the little guy is going to be holding the bag and can't get a fill on his order.

Coincidentally, this is when high frequency trading became lucrative.

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

#122

Post by blacksqr » Thu, Sep 05, 2019, 6:00 PM UTC

I find it grimly amusing that the posters here expressing variations on the "this is fine" position are making the exact arguments that market boosters were making before/during the mortgage finance crisis in 2007/2008.

The problem with those arguments is the fact that what turns a recession into a depression is demand strikes: when the people with cash lose faith in the integrity of the market, they just take their money off the table and go home. Arbitrage and market correction dynamics cease to function.

The fact that depressions can be caused by collapses in demand as well as in supply was the key insight of Keynes et al. in the 1930's, which is why he argued that the government must have the power to regulate markets and the authority to step in and become the buyer of last resort in the face of an incipient depression.

Keynes' insight was conveniently forgotten by the early 2000's, regulation was resisted, the shadow market grew out of bounds, bailouts and stimulus met political resistance, and the rest is history.

How short the time span of memory is.

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

#123

Post by cs702 » Thu, Sep 05, 2019, 6:01 PM UTC

It depends on whether and to what degree indexes are affecting price discovery:

If prices are being set predominantly by active investors who are truly buying and selling based on bottom-up, security-level research, then the percentage of assets that happens to be invested in passive funds is not that important, because price discovery would be working exactly as you and I would hope.

But if prices are being set predominantly by (a) active investors who are chasing indexes because they don't have a choice, (b) active managers who are being forced to sell positions to cope with a high rate of redemptions (from investors who plow that capital back into passive strategies), and (c) traders who grasp this dynamic and shrewdly exploit it for as long as possible; then price discovery might not be working as we would hope. Prices would no longer be reflecting perceived risk; they would be reflecting the (temporary) influence of this once-in-history dynamical process.

Burry makes a compelling case, I think, that the latter is a more accurate description of the current state of financial markets than the former, and that this state of affairs can only persist so long as capital continues to flow from active to passive strategies at such high rates. Globally, assets under management are not infinite, so capital cannot flow indefinitely from active to passive strategies: Sooner or letter, this dynamical process must exhaust itself.

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

#124

Post by AlanSE » Thu, Sep 05, 2019, 6:04 PM UTC

newshorts wrote: post #75

> When an index fund investor sells, they’re technically selling their holdings in direct proportion to their weighting in the index. So there is literally no market impact. Correct me if I’m wrong but isn’t there a well known price premium for stocks included in major index funds? As I understand it, the most popular indexes target a few companies, thus index funds that track them funnel a disproportionate volume of…

I've asked this question before and consistently failed to get a clear answer - why is there any deviation between index fund weighting and market cap?

To some extent, I'm sure the definition of a "public" company comes into play. Not all stocks are traded in all exchanges, so you could include stocks only listed on one exchange.

Then there's the practice of many index funds picking the top N stocks by market cap. This seems like a backwards practice to me. The small cap stocks should be limited in weight by... their small market cap.

Then there are other hairy factors. Even out of the stocks in an index, it seems that weight does not correspond to capitalization. The reason seems to be some historical drivel. While I can understand that is the way it is, I fail to understand why it should be that way.

Why should an equities index fund be anything other than public companies proportional to their size? If people prefer large cap or small cap, then those variations should be offered as special boutique products. But it seems that we have it backwards, where the default offering is based on arbitrary non-proportional weights, and with a cutoff restricting it to large cap.

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

#125

Post by qaq » Thu, Sep 05, 2019, 6:04 PM UTC

cs702 wrote: post #123

It depends on whether and to what degree indexes are affecting price discovery: If prices are being set predominantly by active investors who are truly buying and selling based on bottom-up, security-level research , then the percentage of assets that happens to be invested in passive funds is not that important, because price discovery would be working exactly as you and I would hope. But if prices are being set pre…

And there would be hedge funds that would try to exploit this eventually pushing things back into balance

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

#126

Post by solotronics » Thu, Sep 05, 2019, 6:05 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.

I wonder what the breakdown is within the index ETFs on what money is in 401ks, Roth, institutional investor, etc. If a big portiton of it is retirement accounts those aren't moving much anyways.

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

#127

Post by joyjoyjoy » Thu, Sep 05, 2019, 6:10 PM UTC

wbl wrote: post #14

secabeen wrote: post #8

Earlier quoted context omitted.

The index fund is holding the underlying stock, largely. The challenge is that if say 5% of their fund holders sell their shares in the fund, the fund has to sell the underlying stock to generate the cash to pay out. Most funds have a rule in their documents that if you are a large fundholder (holding 1% or more of the fund) and you sell, they can hand you stocks directly rather than selling them and giving you cash,…

So? They sell others buy. If I hear there is a squeeze and have cash I'll throw it in: who wouldn't? It's never the case that x٪ of the market can exit at once regardless of how it is owned.

"If I hear there is a squeeze and have cash I'll throw it in:" For how many billions will you buy? And why did you not throw it in in 2008?

"who wouldn't?" People who are leveraged?

"It's never the case that x٪ of the market can exit at once regardless of how it is owned." You may not have heard it. But this is called a stock market crash. One is expected soon. So enjoy the ride and keep your money dry that you can "throw it in"

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

#128

Post by rdm70 » Thu, Sep 05, 2019, 6:15 PM UTC

doubleunplussed wrote: post #85

perspective1 wrote: post #24

Earlier quoted context omitted.

Exactly. The article, starting with the title, is pompous and overconfident. Burry made the unanswered point that in a sell-off large index funds will have to dump their smaller holdings at large discounts. We have never had a market crash with passive holdings this large (and consolidated in a small handful of funds)-- we're in unprecedented times. Burry's point is entirely plausible. And although that it wouldn't i…

By symmetry, shouldn't the rapid growth of index funds imply the funds have paid inflated premiums to buy illiquid stocks? I suppose the 'bubble' claim is that they have, but that this is invisible because it has inflated the price of the underlying stocks as well so we still see the index funds priced the same as the underlying stocks. At least for exchange-traded funds, it would seem that you don't have to actually…

The thing is, price moves are not symmetric up and down. Down tends to be much more violent.

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

#129

Post by AlanYx » Thu, Sep 05, 2019, 6:17 PM UTC

hogFeast wrote: post #99

thanatropism wrote: post #62

Earlier quoted context omitted.

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…

Thanks for this -- your comment above about "transforming something illiquid to something liquid" and dcolkitt's post above explaining the possible consequences when indexed ETFs are substantially more liquid than many of the underlying securities really helped me understand the crux of Burry's argument. Are you aware of any academics that are studying this issue or modeling the risks?

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

#130

Post by chawco » Thu, Sep 05, 2019, 6:19 PM UTC

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 doesn't it seem like that, as total ownership of the market shifts towards passives, higher returns would be driven by funds running active strategies such as these, thus making them more attractive investments? It seems like this sort of thing chases an equilibrium.