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Why Index Funds Are Like Subprime CDOs

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Re: Why Index Funds Are Like Subprime CDOs

#261

Post by saimiam »

ckdarby wrote: post #257
badfrog wrote: post #247

Earlier quoted context omitted.

There is no market rule that prevents a single stock from dropping 99% in a day. LULD only halts trading for a few minutes, then there's an auction that could result in any price.

There is no market rule that requires a single stock from not being halted. Please show me a one day 99% drop on a stock. Trading would be halted well before that to prevent manipulation or errors.

If it were a straight drop of 99% - say it is trading at $100 at tick_1 and at tick_2, it is trading at $1, trading will be halted at point which happens to be after a 99% drop. In reality, stocks gap downwards in a series of shallow steps which are unlikely to be 99% in one tick.

More info on the 10% trading halt rule: https://www.nasdaqtrader.com/Trader.aspx?id=TradeHalts

Re: Why Index Funds Are Like Subprime CDOs

#262

Post by kevindong »

ptero wrote: post #140
markbnj wrote: post #58

Not knowledgeable on these matters, so my money is in index funds. Obviously a lot of other people are in the same category as myself. The article seems to be saying we'd all be better financial citizens if we put our money into actively managed funds, or did our own investing. The latter is out of reach for most people, and with respect to the former it's somewhat puzzling that managed funds can't consistently outpe…

I will try to interpret, but obviously it is just my interpretation (and personally I mostly agree with many theses Burry gave). First, he does not really talk about being a "good citizen" or not. His points are for "greedy citizens" who, in his view, should be worried (about his pocketbook) if he is heavily invested in passive index funds. This is due to his "bigger and bigger crowds, same exits" analogy: individual…

> If customers ask for 1% of index funds to be sold, index funds have to sell 1% of their holdings in the exact ratios defined by the index, including stocks with low trading volumes.

Index funds generally aren't super rigidly defined in terms of 1% Company A to 1 % Company B to 3% Company C, etc. which grants them leeway to precisely not have to sell off their assets in precise ratios to maintain a certain portfolio composition.

Index funds do not seek to perfectly replicate whatever sector/market they're seeking to index, but rather they are trying to approximately track the overall change. You can ignore portions of the market while still tracking it to a very close degree (i.e. sampling a distribution).

Re: Why Index Funds Are Like Subprime CDOs

#263

Post by [deleted] »

gizmo686 wrote: post #98
groundlogic wrote: post #34

Earlier quoted context omitted.

Index funds have become successful since they've performed well compared to active investment funds. Why would the active investors suddenly get better at guessing the future?

Active investors are already really good at guessing the future. Index funds work because they follow the decisions made by active investors without needing to pay said investors. As more of the market moved to indec funds, a smaller amount will be controlled by active investors, which will make the entite market dumber (I would say less efficient, but that would include the cost of managing the fund). As the market…

[deleted]

Re: Why Index Funds Are Like Subprime CDOs

#264

Post by thekyle »

ptero wrote: post #140
markbnj wrote: post #58

Not knowledgeable on these matters, so my money is in index funds. Obviously a lot of other people are in the same category as myself. The article seems to be saying we'd all be better financial citizens if we put our money into actively managed funds, or did our own investing. The latter is out of reach for most people, and with respect to the former it's somewhat puzzling that managed funds can't consistently outpe…

I will try to interpret, but obviously it is just my interpretation (and personally I mostly agree with many theses Burry gave). First, he does not really talk about being a "good citizen" or not. His points are for "greedy citizens" who, in his view, should be worried (about his pocketbook) if he is heavily invested in passive index funds. This is due to his "bigger and bigger crowds, same exits" analogy: individual…

> If customers ask for 1% of index funds to be sold, index funds have to sell 1% of their holdings in the exact ratios defined by the index

I'd like to point out that while this may be the case for traditional mutual funds, it is not for ETFs. ETFs don't redeem shares for cash they redeem them for equities in the underlying index. So ETFs don't actually buy or sell any securities unless they rebalance.

Re: Why Index Funds Are Like Subprime CDOs

#265

Post by droithomme »

I don't know man. Index funds seem to be the safest bet you can make as far as balancing risk and growth. You're betting that the world in general won't collapse over the long term. And if it does any high growth strategy is probably going to collapse with the general world as well so isn't that much safer.

What is fascinating is that here is an article claiming that one of the safest bets you can take is the same as one of the biggest most corrupt and deplorable scams of the last 50 years. Now that's interesting because we want to take a look at who wrote that, who published it, and wonder what the heck they are up to peddling this view.

Re: Why Index Funds Are Like Subprime CDOs

#267

Post by dehrmann »

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?

A large cap index fund wouldn't have the same liquidity problems, but it has the problem that if this were to happen, funds might have to sell their large cap holdings to cover outflows, driving down those prices. At least it would reflect the NAV, though.

You could buy a closed-end mutual fund since it won't be balancing its holdings in the same way.

You could buy a small cap fund and short a large cap fund, betting that small cap shares will get distorted in the positive direction if there's a liquidity crunch.

I guess I'm somewhat less worried about people not picking stocks because hedge funds, and really, anyone greedy, will always try to do that, bringing some amount of pricing to the market.

Re: Why Index Funds Are Like Subprime CDOs

#268

Post by tardo99 »

Peej255 wrote: post #2

If true what's the hedge? Pension and investments to cash and bonds? Japanese stocks?

This reminds me of the article someone else posted today about six sigma, where commenters rightly pointed out that the methodology works until companies try to use it to replace actual thinking managers.

The hedge is simply to pay attention and make your own decisions. Index funds are great in general, but not when markets get out of whack (bubbles, etc).

Re: Why Index Funds Are Like Subprime CDOs

#269

Post by cogman10 »

kevindong wrote: post #262
ptero wrote: post #140

Earlier quoted context omitted.

I will try to interpret, but obviously it is just my interpretation (and personally I mostly agree with many theses Burry gave). First, he does not really talk about being a "good citizen" or not. His points are for "greedy citizens" who, in his view, should be worried (about his pocketbook) if he is heavily invested in passive index funds. This is due to his "bigger and bigger crowds, same exits" analogy: individual…

> If customers ask for 1% of index funds to be sold, index funds have to sell 1% of their holdings in the exact ratios defined by the index, including stocks with low trading volumes. Index funds generally aren't super rigidly defined in terms of 1% Company A to 1 % Company B to 3% Company C, etc. which grants them leeway to precisely not have to sell off their assets in precise ratios to maintain a certain portfolio…

Which is why it is weird he compares them to CDOs.

Indexes typically don't have a fixed set of underlying securities. CDOs do. Your index fund typically won't tank because one of it's holdings become unprofitable, the fund will adjust reducing shares of said fund and thus reducing risk.

That doesn't happen with a CDO. If you're AAA mortgage holder starts having financial troubles, you can't readjust the CDO to reduce exposure.

Take an S&P 500 index as an example. If company 500 starts having a crappy quarter and falls out, what happens to your index? You dump the old 500 for the new one.

This isn't too say they aren't without risk. Just that it is a completely different financial vehicle than a CDO. So different that trying to make comparisons isn't really prudent.

Re: Why Index Funds Are Like Subprime CDOs

#270

Post by anm89 »

Terr_ wrote: post #231
drelihan wrote: post #127

Earlier quoted context omitted.

Imagine there was a cookie market made up of two types of cookies, tasty and meh. An active investor in cookies would spend time determining which cookies are likely tasty and which are meh. They would pay more for the tastier cookies so they can savor the flavor and less for the meh ones they can binge eat in the shower when no one is home.... A passive investor comes along and says, I don't want to do all this rese…

"What if everyone became a passive investor" is like worrying "What if the entire ecology became defenseless herbivores?" It just won't happen, because there's a negative feedback loop against it, leading to a kind of homeostasis. > At some point, no one is left to figure out which cookies are tasty vs meh, so the price of all cookies converge to a single price. Five minutes later someone says: "Holy shit, I can make…

Everyone here doesn't mean literally everyone. It means enough of everyone. And he's arguing it's already happened. And I agree.
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