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

#21

Post by jackcosgrove » Thu, Sep 05, 2019, 4:12 PM UTC

lacker wrote: post #5

I believe index funds are a good investment strategy, but at the same time we shouldn’t get defensive when people criticize them, and call a thoughtful critique “silly”. In fact I would like to hear more intelligent criticism of index funds, and thoughts around preparing for a hypothetical world in which index funds were overrated, not less. How might we notice that index funds were becoming overrated? Perhaps the ri…

I found an inconsistency in the article.

> We’re just seeing a shift from closet indexing to ETFs and other index funds en masse now that investors have wisened up.

So active managers are copying the indexes.

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

But indexes buy what the active managers pick.

The author appears to be confused as to who is the tail and who is the dog. Maybe this is resolved by saying some active managers do price discovery, but most are just copycats. It's not clear though.

For the record I think index funds are still the best choice for a retail investor, and the article is mostly true. Namely

> Many of the worries about indexing really boil down to career risk in the asset management space.

Some of the arguments seem to be hasty and not well presented though.

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

#22

Post by sambe » Thu, Sep 05, 2019, 4:12 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.

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" - relatively small part of the trading volume.

* "Liquidity is not a huge problem for index funds" -no market impact to sell (v dubious if you ask me), unlevered.

* "Humans matter more than fund structures" - the absence of index funds did not prevent bubbles/crashes.

You can disagree with those points (I do with some of them) but that's a large part of the article.

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

#23

Post by rmah » Thu, Sep 05, 2019, 4:13 PM UTC

lacker wrote: post #5

I believe index funds are a good investment strategy, but at the same time we shouldn’t get defensive when people criticize them, and call a thoughtful critique “silly”. In fact I would like to hear more intelligent criticism of index funds, and thoughts around preparing for a hypothetical world in which index funds were overrated, not less. How might we notice that index funds were becoming overrated? Perhaps the ri…

But the original critique was silly. And surprisingly so given the source.

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

#24

Post by perspective1 » Thu, Sep 05, 2019, 4:13 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.

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 immediately cause a problem for investors who don't sell (price is not value), the newly discount-price firms may struggle immensely in terms of raising new capital and financing.

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

#25

Post by C1sc0cat » Thu, Sep 05, 2019, 4:15 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.

And ignores the current example of the neil woodford equity income fund.

This is a smaller example the liquidity problem that Mr Burry was making - it would much worse if a market crash did this to the realy realy big index funds.

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

#26

Post by kolbe » Thu, Sep 05, 2019, 4:16 PM UTC

Reminder: "index funds" are also managed by humans. For example, all stocks in the S&P 500 are chosen by Standard & Poors. Stocks are added and removed as they see fit based on various criteria such as profitability, float, market cap, &c. The only things that I can see that truly differentiate S&P from other active managers are that they

(a) have very little skin in the game.

(b) they get to make decisions about what other people have to do with their money

(c) they tend to recommend more stocks with less turnover than typical active managers

(d) they tell the public ahead of time what will be bought or sold, so traders get to buy/sell ahead of time

(e) their actions are relatively predictable, thanks to a long history of sticking to their stated goals.

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

#27

Post by C1sc0cat » Thu, Sep 05, 2019, 4:16 PM UTC

0xcafecafe wrote: post #4

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.

What if my index fund is actually just buying and holding the underlying stock as opposed to just a price tracking entity? In that case not taker for my fund = no taker for the underlying stock right? Will this not have the liquidity risk that Bury mentions?

They are mostly not doing physical replication (physically owning all the shares) but using synthetic means.

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

#28

Post by kjs3 » Thu, Sep 05, 2019, 4:17 PM UTC

awillen wrote: post #7

As I read it, the word bubble in the Burry interview was really just used for clickbait purposes - his argument wasn't so much that index funds are overvalued, it was that there's opportunity in small caps because they're underrepresented in index funds, and everyone else is investing in index funds.

I don't think so (although bubble is clearly a loaded term). As I understand it, the other part of Burry's argument is that the passive funds distort the market such that if there's a rush for the door there wouldn't be sufficient liquidity to prevent a crash.

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

#29

Post by asdkfjasl » Thu, Sep 05, 2019, 4:18 PM UTC

josu wrote: post #19

mrep wrote: post #11

Earlier quoted context omitted.

How would they lose liquidity? Authorized participants [0] are always in the market for ETFs. If an ETF share price is crashing out of line with the index it tracks, they will step in and buy shares, swap them with the ETF issuer for the shares of the underlying stock in the index, and sell those shares for an arbitrage profit. Even if one of the underlying stocks becomes illiquid, a big enough price divergence on al…

>You'd basically need the entire market to become illiquid. Yes. It has happened before.

OK, but in that case is there a distinction between index funds and actively managed funds? Is this a risk that index funds are uniquely exposed to?

Also, another thing to keep in mind is that this only affects people who are trying to sell at the bottom. Buy and hold investors care little for liquidity issues during a crash.

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

#30

Post by C1sc0cat » Thu, Sep 05, 2019, 4:18 PM UTC

TomGullen wrote: post #20

If an index selloff could cause a drop in underlying stock price, wouldn't we see this effect when stocks are relegated from various indexes? Does this effect exist?

Yes and hedgefunds play this game for example M&S getting dumped from the FTSE 100