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A critique of the claim that passive investing is a bubble

awealthofcommonsense.com

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

#41

Post by adventured »

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.

Just the fact that the author chose to call Michael Burry's well thought out premise "silly" - tells you most of what you need to know about what is being pitched in the article. I've never seen Burry say anything that qualified as silly, even when a premise of his doesn't play out as dramatically as predicted. Silly is entirely contrary to his personality and analysis, it's attempting to lead the reader and argue via ridicule (where did we see that before?).

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

#42

Post by Aunche »

gzu wrote: post #38
kolbe wrote: post #26

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 wha…

The S&P 500 is basically a group of largest established 500 market cap stocks traded in the US proportioned to market cap. There is no active management determining price and weights here.

I don't think so. Otherwise Uber and Snap would both be in the S&P 500.

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

#43

Post by crb002 »

I don't buy the liquidity argument. Their mere existence creates liquidity. Two sides to every trade. Index fund "sell offs" will likely go to buyers of the same index fund shares but at a lower price.

Apple alone has $50 billion in cash that will flow into Vanguard if index funds hit a 50% plunge. Same with Buffet. Index funds may be bubble priced, but they don't suffer from a liquidity issue.

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

#44

Post by peteradio »

FabHK wrote: post #37
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.

> 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 When investors sell that amount, it doesn't matter whether they hold the underlying assets directly, or via index funds or ETFs, or via actively managed funds. The market will go down. So, which part of the problem is uniquely due to index funds? Burry hasn't made that point very clear…

Requirement to sell across the board seems to be the unique issue.

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

#45

Post by FabHK »

perspective1 wrote: post #24
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 i…

> Burry made the unanswered point that in a sell-off large index funds will have to dump their smaller holdings at large discounts.

First, I think he didn't made that point very clearly. Second, why would they be sold at a larger discount than larger holdings? It is all in proportion - they own less and sell less of the smaller holdings.

(There are issues conceivable where you have a liquidity mismatch (bonds, real estate), but I haven't seen a solid elaboration of that point. It's the good old "people worry about bond market liquidity" meme that Mark Levine pokes fun at in his Bloomberg Column "Money Stuff".)

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

#46

Post by thanatropism »

asdkfjasl wrote: post #29
josu wrote: post #19

Earlier quoted context omitted.

>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.

Well,

1) To track the actual index, index funds must continually rebalance their portfolio. In a liquidity pause they may not be able to do this, thereby becoming a non-index fund. Actively managed funds have the portfolio they have -- unless they're defrauding the public somehow. An index fund that becomes a non-index fund would fall in this latter category.

2) The index (not the funds) is assumed to reflect all the information that can be used to make some money by arbitrage. This process is referred as "price discovery". But in a liquidity pause, price discovery grinds to a halt. Actively managed funds have their own idea of what are the fundamental prices beyond what the public leaderboard says; their price discovery is not beholden to the existence of a liquidity market. Actually -- if the market goes for years with very low liquidity, it becomes more likely that people who, say, are shorting Herbalife for fundamental reasons, have more knowledge than the index. In this way the index is like an AI that can become starved for data.

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

#47

Post by 0xcafecafe »

C1sc0cat wrote: post #27
0xcafecafe wrote: post #4

Earlier quoted context omitted.

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.

Not really. The most popular index funds physically invest their capital in the stocks making up the index:

https://www.investopedia.com/articles/markets/101415/4-best-...

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

#48

Post by omgwtfbyobbq »

perspective1 wrote: post #24
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 i…

The idea that we've never had a market correction with passive holdings at current levels is accurate. It also was an accurate statement in 2008, and it also applies to foreigners and mutual funds now, both of which have increased their holdings of equities over time and both of which have substantially greater holdings than index funds.

https://awealthofcommonsense.com/wp-content/uploads/2019/09/...

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

#49

Post by thekyle »

gzu wrote: post #38
kolbe wrote: post #26

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 wha…

The S&P 500 is basically a group of largest established 500 market cap stocks traded in the US proportioned to market cap. There is no active management determining price and weights here.

Technically, the S&P 500 isn't actually the largest 500 companies by market cap. S&P has a committee that decides to exclude some stocks.

That said, for all practical purposes it is basically the 500 largest companies.

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

#50

Post by FabHK »

C1sc0cat wrote: post #27
0xcafecafe wrote: post #4

Earlier quoted context omitted.

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.

Source? In the jurisdictions I'm familiar with, synthetic ETFs come with special warnings (even in the fund name), and they're definitely not the majority.
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