Hacker News Board Hacker News, browsed like a classic message board
Live data from Hacker News

A critique of the claim that passive investing is a bubble

awealthofcommonsense.com

Post reply on HN
Print view View original

141–150 of 200 posts

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

#141

Post by christophilus »

dkarl wrote: post #70

As others have noted, there's a lot here that isn't relevant to Burry's argument, but this seems like the key rebuttal to me: Active funds literally own the market. When you buy an index fund of the total stock market, you are literally buying the stock market in proportion to the shares held by all active investors. If you sum up the collective holdings of active managers, what you basically get is a market-cap-weig…

> Index fund investors are simply buying what the active investors have laid out for them.

That works until it doesn't. If passive becomes big enough, the indices themselves will be the ones steering the ship. The active managers won't be significant enough to sway the indices.

I heard this analogy on a podcast (I think it was Invest Like the Best): Indices are like a drunk person, and active managers are like the sober friend guiding the drunk home. But if the drunk becomes 10x the size of the sober friend, the friend is no longer strong enough to be a guide.

If passive funds get big enough to dwarf active management, they eventually will be the ones steering the market, and active investors will be noise at that point. In that scenario, I'm not sure what happens, but it seems that indexing would become more like a Ponsi scheme.

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

#142

Post by rocqua »

human20190310 wrote: post #10
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.

> ...will drive the market down So what? Let the weak long positions panic and sell at the bottom. Everyone else gets a few years of discount prices to buy. The hardest hit will be those who are leveraged and arguably deserve to get hosed for taking that much risk. If you don’t have to meet a margin call, you can ride out a crisis; if you’ve got cash in reserve, you can profit from it.

Presuming you are saving for later. Besides a margin call, you might want to exit for, buying a house, going into retirement, covering a period between jobs, or to deal with a medical emergency.

Doing that during a crisis hurts. This risk diminishes the value of investments as a safety cushion.

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

#143

Post by smogcutter »

navigatesol wrote: post #94
dcolkitt wrote: post #64

Earlier quoted context omitted.

> "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 th…

Right? I don’t see what the fuss is about. If the argument boils down to “price and liquidity will drop in a sell-off”, well that’s basically a law of nature. I don’t see why index funds are a special case.

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

#144

Post by talolard »

sambe wrote: post #22
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.

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…

I think they talk about it but didn't add up to a rebuttal or challenge of Burry's liquidity point. I think they claim is that their is a lot of "dumb money" holding indexed products that are likely to sell all at once when things turn south. By the structure of these funds, their will be large selling pressure on the underlying stocks and a good chunk of them don't have the liquidity to support that pressure. That doesn't mean their will be a metldown, just that prices will tank very hard and a lot of people will lose a lot of money + the economic effects that has I don't understand.

I was hoping the original article would tear that reasoning down, and while it did touch on various mechanisms it didn't give a cohesive thesis as to why that is wrong.

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

#145

Post by nickles »

travisoneill1 wrote: post #111
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 m…

> 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.

ETFs are securities that trade freely. They may be open ended or closed ended, but the price of both is determined independent of 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 is the creation/redemption mechanism and is actually responsible for keeping the market cap of open ended ETFs in line with the NAV. Closed ended funds don't have such a mechanism, so the cap may diverge from the NAV.

> 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).

This defeats the tax advantages of the ETF structure. Instead of having the manager buy and sell names, APs (authorized particpants) do the trading, hedging with units of the ETF. They then do an in-kind exchange with the fund manager at the end of the day. If the AP has net purchased the underlying basket, they will exchange the basket for shares of the ETF (creation). If the AP is net short the basket, they will exchange their offsetting ETFs for the underlying basket (redemption). This should affect the volume of the constituents.

Some ETFs do not require creation and redemption to be done with the full basket of index members. These tend to be based on names that trade less frequently. In this case the manager allows a subset of the index to be exchanged. In this case, the creation/redemption mechanism will not necessarily affect the volumes of all members of the index. Note that this can could cause tracking error.

Managers will rebalance when the index the fund is based on changes. For example, bond ETFs generally rebalance once a month. Market cap weighted ETFs (as opposed to, for example, equal weighted ETFs) are easier for managers as well, because the fund doesn't need active rebalancing.

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

#146

Post by vkou »

rocqua wrote: post #140
vkou wrote: post #135

Earlier quoted context omitted.

They aren't required to sell, unless fund-holders are selling their ETFs. If those fund-holders were owning the stocks directly, instead of ETFs... Those same fund-holders would be... Selling their stocks. Causing the exact same downward price pressures.

If I sell my ETF, the AP buys it from me, and gets to redeem it for a basket of shares of fixed proportion. Suppose stock X gets 1% in that basket. The issue is if stock X happens to be very illiquid, the APs selling stock X could drive down the price. In a non ETF, managers could decide to relatively slow down the sale of X, to prevent crashing the price. However, in an index fund the mechanism dictates all stocks a…

An evil mirror universe twin of you, instead of owning an ETF, owns a bunch of shares of APPL, a bunch of shares of GOOGL, a bunch of shares of stock X.

If you are panicked, and are selling your ETF, your evil twin is panicked, and selling all their stocks.

This causes the exact same downwards pressure on the market.

I don't buy an ETF because I want someone to do financial malarkey with my money. I buy it because I want to own stocks, and I can't be assed to deal with my own brokerage account. Besides the convenience aspect, there is zero difference between the two.

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

#147

Post by tjpaudio »

"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"

This is a straight out false statement. Who is this guy again? Oh yea, he has his hands in passive investment big time.

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

#148

Post by dcolkitt »

Raidion wrote: post #100
dcolkitt wrote: post #92

Earlier quoted context omitted.

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…

> I'd have a hard time believing some niche hedge fund somewhere wouldn't make a killing off this by providing liquidity.

Typically the opportunists here would be stat-arb hedge funds. They bread and butter of their strategy is to isolate the non-explainable ("idiosyncratic") movement in single name stocks, then bet on that factor mean-reverting.

E.g. if Microsoft goes down 0.5%, but the market's up 1%, and the tech stocks are up 1.2%, and various other factors that move Microsoft don't explain it being down. Then they'll bet that the movement is driven by random noise, and buy Microsoft, betting that it will re-converge with where it's expected to be. They'll also use various techniques to isolate whether idiosyncratic movements are likely driven by company specific factors or market noise. Like NLP on a newsfeed to look to see if there are any breaking stories, or tracking recent analyst revisions on the stock.

Suffice to say that stat-arb funds in this day and age are very very good at this. In a liquidity unwind event, the signals stat-arb traders use would absolutely be lighting up. The biggest question would be whether stat-arb funds in aggregate have enough capital to counter the absolutely humongous flows that a potential index fund unwinding would release.

Another complicating wrinkle is that most stat-arb desks are no longer independent hedge funds, but units within larger multi-strategy funds (like Two Sigma or Millennium). There's good and bad. The good is that if there's all of a sudden massive opportunity the multi-strat fund can quickly reallocate more capital to the stat-arb desk.

The bad part is that stat-arb desks may be unwound due to arbitrary contagion in other parts of the market. If the multi-strat fund sees a big loss in another unit, it may pull capital from the stat-arb desk to meet margin calls or redemptions. For example this happened in August 2007 [0]. The subprime mortgage market blew up, then all of a sudden a bunch of esoteric stocks started behaving crazy for the next weeks. And that was largely because multistrat funds were pulling capital to meet margin calls on their mortgage portfolio.

[0] http://web.mit.edu/Alo/www/Papers/august07.pdf

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

#149

Post by rocqua »

vkou wrote: post #146
rocqua wrote: post #140

Earlier quoted context omitted.

If I sell my ETF, the AP buys it from me, and gets to redeem it for a basket of shares of fixed proportion. Suppose stock X gets 1% in that basket. The issue is if stock X happens to be very illiquid, the APs selling stock X could drive down the price. In a non ETF, managers could decide to relatively slow down the sale of X, to prevent crashing the price. However, in an index fund the mechanism dictates all stocks a…

An evil mirror universe twin of you, instead of owning an ETF, owns a bunch of shares of APPL, a bunch of shares of GOOGL, a bunch of shares of stock X. If you are panicked, and are selling your ETF, your evil twin is panicked, and selling all their stocks. This causes the exact same downwards pressure on the market. I don't buy an ETF because I want someone to do financial malarkey with my money. I buy it because I…

Unless everyone has an evil twin, there is less chance of everyone wanting to exit X at the same time. Hence there won't be a run on X.

Moreover, if my evil twin a) owned a managed fund or b) sold in a slightly smarter way, then they would lose less on X due to liquidity.

Moreover, the hit on Xs price also has a slight hit on the ETF value. Hence there is a small positive feedback loop.

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

#150

Post by thekyle »

gnicholas wrote: post #72
IshKebab wrote: post #68

Earlier quoted context omitted.

People more or less do do that. I've often searched for something on Amazon and bought the most popular result.

Sure, but do you buy a bundle of goods this way? That’s the analog of index investing.

What's the difference between going and buying 10 top goods individually and buying a bundle that contains those same 10 top goods.
Post reply on HN