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

#171

Post by throw0101a » Thu, Sep 05, 2019, 8:16 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.

Why would they need to cash out their positions? Indexes seem to actually have inflows during bear markets. See Point 2:

* https://www.etfstrategy.com/three-reasons-why-indexing-and-e...

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

#172

Post by throw0101a » Thu, Sep 05, 2019, 8:18 PM UTC

talolard wrote: post #144

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…

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 d…

> 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.

There is no evidence for this. During the 2000-2002 and 2008-2009 index funds actually saw higher inflows:

* https://www.etfstrategy.com/three-reasons-why-indexing-and-e...

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

#173

Post by hogFeast » Thu, Sep 05, 2019, 8:24 PM UTC

thanatropism wrote: post #136

hogFeast wrote: post #99

Earlier quoted context omitted.

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…

My beef is with your form (starting a meta comment thread to shit on the ongoing discussion rather than engaging with the discussion). I actually agree very closely with your views.

Again, I did engage with the discussion. You just seem to think it is irrelevant.

I am actively disinterested in all the nonsense around population share of active/passive or whatever the Twitterati are bleating about. I have seen enough of these situations to just not care anymore about anything other than the two things I mentioned.

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

#174

Post by hogFeast » Thu, Sep 05, 2019, 8:32 PM UTC

AlanYx wrote: post #129

hogFeast wrote: post #99

Earlier quoted context omitted.

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?

Well, I suppose the literature around the liquidity premium relates to this topic. But liquidity is fairly simple (and drives the market cycle): liquidity is worthless in booms, and very valuable in busts.

But something to note here too: most measures of historical returns do not look at liquidity either. I am in the UK, and I know there is research (I can't find it atm) showing that before 1970s, trading costs were significant. Historical returns rarely reflect that. Nor do they reflect the fact that most people before 1970 probably couldn't own any asset other than govt bonds (or that most banks were forced to own them too).

So I would say the issues with indexes are two-fold. First, they will fail if they are built on illiquid securities (recent example here is also Neil Woodford's implosion). Second, they are often predicated on historical returns that are, in any non-academic/practical sense, fictional.

Another reply is Horizon Kinetics...apart from GMO, they are the only investment manager whose letters I actually read. And on ETFs, they have written a lot.

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

#175

Post by lovecg » Thu, Sep 05, 2019, 8:39 PM UTC

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.

Systemic risk. If a ton of smaller companies see their shares plummet all at the same time, there might be repercussions for the economy as a whole. It’s true that individual investors might be able to ride it out (and the same was true in 2008).

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

#176

Post by lovecg » Thu, Sep 05, 2019, 8:42 PM UTC

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…

The argument is that the automation at scale that ETFs bring to the table changes the game qualitatively. How many people would really buy and sell thousands of individual stocks in a correlated fashion if this infrastructure didn’t exist?

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

#177

Post by yifanl » Thu, Sep 05, 2019, 9:12 PM UTC

thekyle wrote: post #150

gnicholas wrote: post #72

Earlier quoted context omitted.

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.

Nothing, but the analogy would be buying the Amazon top-seller of every product category.

It doesn't make sense, you aren't going to use any of those products, you don't even care what most of them are.

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

#178

Post by fyz » Thu, Sep 05, 2019, 9:31 PM UTC

talolard wrote: post #144

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…

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 d…

What would said dumb money be holding if not index funds? Single name blue chips? What would the blue chip holders do in the counterfactual world where there is a big downturn?

Perhaps there will be greater correlation between names in a downturn, but then again, factor-based investing might offset some of that.

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

#179

Post by human20190310 » Thu, Sep 05, 2019, 9:38 PM UTC

rocqua wrote: post #142

human20190310 wrote: post #10

Earlier quoted context omitted.

> ...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.

Index funds aren’t a safety cushion. Vanguard rates it’s own S&P 500 index fund as a 4 out of 5 for risk. [0]

[0] https://advisors.vanguard.com/iippdf/pdfs/FS540.pdf

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

#180

Post by dcolkitt » Thu, Sep 05, 2019, 9:42 PM UTC

hyperpape wrote: post #169

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 great explanation. Can you explain why this isn't a problem for actively managed funds, though? Do they just avoid stocks like CB?

No, I think in such a scenario active investors would wind up getting just as whalloped as passive investors. By definition active investors in aggregate have the same average exposure as cap-weighted indexers to any given stock.

Arguably, after the crash they might be able to take advantage of the opportunity. If they concentrate into the stocks with the biggest price displacements, then as those stocks return to normal, they may make up some or all of their initial losses. Passive indexers can't do this, because they don't have the mandate to deviate from their pre-defined allocations.

But I think the broader issue is that excessive amounts of indexing present potential systematic risks for everybody. Burry's hypothesis is more relevant for policymakers than it is for investors.

As an individual, long-term buy-and-hold investor, low-cost index funds are without question the best option for investing. The problem is behavior that's rational on an individual level, may produce irrational results at the collective level.