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Why Index Funds Are Like Subprime CDOs

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Re: Why Index Funds Are Like Subprime CDOs

#311

Post by repolfx »

pas wrote: post #283
charwalker wrote: post #179

Earlier quoted context omitted.

There is an interesting idea when index funds are taken to an extreme in that if no one is manually playing the market or managing investments then everything is invested in at the same or similar rates. Index funds need active traders to trade and set pricing within the market. My analogy would be if we are all buying tickets to the big game and sit in the stands until it's over, there's no one to yell and shout and…

But the wisdom of the crowd, the price signal, only works if professionals look at the stocks. And it requires only a few [hundred] of them (with big enough leverage, so their position shows up). For the top 500 stocks there are enough people (and algos) going over every bit released by the corresponding companies.

That's a contradiction. It's not the wisdom of the crowds if only a few hundred people are really looking at things. The whole point of that expression is that you need a crowd, to avoid groupthink, capture etc

Re: Why Index Funds Are Like Subprime CDOs

#312

Post by repolfx »

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…

That assumes it's possible to retain a deep understanding of a company or industry whilst being outside of and focusing full time on "money management". It's the same school of thought that says corporate management is a generic skill that people can/should be taught and then they can manage anything.

Re: Why Index Funds Are Like Subprime CDOs

#313

Post by danw1979 »

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…

> It wasn't just a "psychological overreaction" but real fear and panic as those same investors were trying to squeeze through the same exit door as everyone else.

Panic is quite literally a psychological overreaction.

Re: Why Index Funds Are Like Subprime CDOs

#314

Post by danw1979 »

segmondy wrote: post #255
mcguire wrote: post #227

Earlier quoted context omitted.

If 1% of the money in index funds exited the market in any form (not just index fund withdrawals), it's going to be a bad day any way you look at it.

I think the fund managers know this and will collude to prevent it from happening. They are smart enough to know about game theory, it's not their money. So they can sit and not go on a selling frenzy.

Are they manually managed though ? isn't there an algorithm somewhere responsible for balancing these funds ?

Re: Why Index Funds Are Like Subprime CDOs

#315

Post by wnissen »

wcunning wrote: post #77
jpmattia wrote: post #51

Earlier quoted context omitted.

Most folks here are focusing on Burry's comments regarding price-discovery. However there is another huge point: Liquidity risk. To understand his point, you have to know the gory details of how an ETF operates. First: When you buy a ETF share for the S&P 500 (iShares, Vanguard etc), the share is not backed by all 500 S&P components. Virtually all the large-number component ETFs are using a sampling of shares to matc…

This feels like the most concise explanation of the underlying mechanics that I was intuiting from the article. Now the question becomes: how do I hedge out of this risk without going full day-trader?

My guess is that would be more expensive than what the index fund / ETF would cost you even in a worst case scenario. Read my comment where over the last 10 years Vanguard has only deviated by 1%, even after factoring in trading costs. A typical active fund is going to charge .5% per year, minimum, which adds up to 10% over 10 years, assuming a 7% annual return. A more typical 1% expense ratio is going to be 20%. Active management is extremely expensive. But trading yourself, unless you have a million, is going to be expensive, too. IF you wanted to DIY, $5 a trade adds up if you're putting money into multiple stocks every month. $1000 divided into 10 stocks a month is going to be a 5% expense before you even get started.

Re: Why Index Funds Are Like Subprime CDOs

#316

Post by edmundsauto »

gizmo686 wrote: post #307
edmundsauto wrote: post #305

Earlier quoted context omitted.

I'm over my toes here, being a programmer and not a finance person, but isn't this viewpoint controversial? IE, does everyone (relatively well informed) agree there are correct prices?

Somewhat. There is arguably an objectivly true answer for exactly what payments a given stock will make, and so there is an objectivly true answer for what the present value of the stock is (also dependent on other aspects of the future market). This is somewhat of a philosiphical question, largly boiling down to determinism; and is largly moot because no one claims to be able to predict the future well enough for th…

Do you consider a probability distribution function as objectively true? If it's not obviously true beforehand, I'm not sure if it's only clear in hindsight, which has all kinds of psychological issues in interpretation.

IOW, is there any practical difference between "there is no objectively correct price" and "we'll never know what it is"? The price at any given time reflects the current consensus of the objective price, distorted through the current average psychological lens of the market?

If something is unknowable before it occurs, we will never know what the objectively true measure is until it's occurred. At which point it changes, since the market is dynamic. How could we ever know which point is the correct price?

Re: Why Index Funds Are Like Subprime CDOs

#317

Post by jiscariot »

anm89 wrote: post #271

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 fun…

I agree...it also has become so commonplace it irks my inner contrarian (having been in ETFs past 20+ years).

-Shoeshine boy starts talking stocks--time to exit the market. [1]

-Dad starts asking me about bitcoin--time to exit bitcoin position.

-Occasionally employed step-sister praising index funds--???

[1] https://archive.fortune.com/magazines/fortune/fortune_archiv...

Re: Why Index Funds Are Like Subprime CDOs

#318

Post by gizmo686 »

edmundsauto wrote: post #316
gizmo686 wrote: post #307

Earlier quoted context omitted.

Somewhat. There is arguably an objectivly true answer for exactly what payments a given stock will make, and so there is an objectivly true answer for what the present value of the stock is (also dependent on other aspects of the future market). This is somewhat of a philosiphical question, largly boiling down to determinism; and is largly moot because no one claims to be able to predict the future well enough for th…

Do you consider a probability distribution function as objectively true? If it's not obviously true beforehand, I'm not sure if it's only clear in hindsight, which has all kinds of psychological issues in interpretation. IOW, is there any practical difference between "there is no objectively correct price" and "we'll never know what it is"? The price at any given time reflects the current consensus of the objective p…

There is a difference between "truth does not exist" and "we cannot know the truth".

In theory, we can take a now worthless stock and look back in time to determine the actual present value at a given point in the past.

In theory, we can imagine an outside observer running an arbitrarily large copies of our universe from a given point in time to determine the probability curve at said point in time (under whatever model of randomness you want to use). More plausibly, we can take a set of predicted probability curves and look back to see how accurate they were (did events predicted with uncorralated 50% probability happen half the time?).

Economics is hard, because it is very difficult to determine these facts, even in retrospect, but they still exist.

Re: Why Index Funds Are Like Subprime CDOs

#319

Post by edmundsauto »

gizmo686 wrote: post #318
edmundsauto wrote: post #316

Earlier quoted context omitted.

Do you consider a probability distribution function as objectively true? If it's not obviously true beforehand, I'm not sure if it's only clear in hindsight, which has all kinds of psychological issues in interpretation. IOW, is there any practical difference between "there is no objectively correct price" and "we'll never know what it is"? The price at any given time reflects the current consensus of the objective p…

There is a difference between "truth does not exist" and "we cannot know the truth". In theory, we can take a now worthless stock and look back in time to determine the actual present value at a given point in the past. In theory, we can imagine an outside observer running an arbitrarily large copies of our universe from a given point in time to determine the probability curve at said point in time (under whatever mo…

> There is a difference between "truth does not exist" and "we cannot know the truth".

If we can't know the truth, how do we know it exists (in this situation)? I'm not convinced there's an objective true value of a stock -- it seems like stock prices are the general consensus of a huge number of subjective inputs. And that will always be the case.

(Definitely appreciate the time and thought you've put into your responses, btw! Thank you.)

Re: Why Index Funds Are Like Subprime CDOs

#320

Post by kd5bjo »

edmundsauto wrote: post #319
gizmo686 wrote: post #318

Earlier quoted context omitted.

There is a difference between "truth does not exist" and "we cannot know the truth". In theory, we can take a now worthless stock and look back in time to determine the actual present value at a given point in the past. In theory, we can imagine an outside observer running an arbitrarily large copies of our universe from a given point in time to determine the probability curve at said point in time (under whatever mo…

> There is a difference between "truth does not exist" and "we cannot know the truth". If we can't know the truth, how do we know it exists (in this situation)? I'm not convinced there's an objective true value of a stock -- it seems like stock prices are the general consensus of a huge number of subjective inputs. And that will always be the case. (Definitely appreciate the time and thought you've put into your resp…

At any given point in time, it's possible to calculate how much value a stock has already given to its bearer via dividends, and adjust those values for the changing purchasing power over of currency over time.

Once a company dissolves, we have enough information to do this calculation over the entire lifetime of the stock issue. At that point, we can determine what real value that stock had at any point in the past for the bearer.

This explains how value investors interpret stock value, but most traders are speculators that expect to make their profit by selling the shares on to someone else. They will only buy a share of stock if they believe that a future investor will buy it off of them at a higher price. This future investor will either be a value investor that expects to get the dividend returns or another speculator that is making the same calculation. Thus, even if a share of stock will pass through many hands before it lands in the portfolio of a value investor, that value investor is the only real price anchor, and the entire chain of speculators are ultimately trying to sell to him/her.

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