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A critique of the claim that passive investing is a bubble

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

#81

Post by david927 »

It doesn't seem silly at all. I agree with Michael Burry; I think passive investing is a bubble -- by definition. If you spent $10 million to make a cafe in your small hometown, you would never get that money back for the obvious reason that you could simply never sell that much coffee. The fundamentals aren't there.

So if you invest in "all coffee shops" or "all shops in my hometown", you're not looking at fundamentals, you're investing to invest. And, by definition, (assuming all shops are priced correctly) you're artificially inflating.

If someone invests across a group of stocks, it's because "the market always goes up over time." And if enough people believe that then it can be true for a very, very long period. But eventually it becomes your $10 million coffee shop. It's a bubble. And even a bubble that lasts decades will eventually pop.

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

#82

Post by bitxbit »

I believe what’s missing from the recent analyses of beta/index investing is that alpha continues to lag when in theory stock pickers should be able to find more mispriced assets. Although volatility around earnings (which serve as valuation reset) has generally increased. Unprecedented bull market and 3/4 of investable wealth now pooling into passives funds simply cannot be overcome. What it does provide is significantly asymmetrical opportunities shorting single stocks.

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

#83

Post by ptero »

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.

This is the way it felt to me, too. The author seems to be cherry picking some incomplete statements from Burry's article and tries to make them sound ridiculous, and sometimes resort to adjectives rather than arguments.

I am not a specialist and would love to read an informed analysis and counters to Burry's article. I was hoping that this is what the author tried (as the title suggests), but to me he fell far short of that goal. My 2c.

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

#84

Post by sct202 »

I'm a little confused about the point about index funds being a small percentage of assets, when there are constantly articles like "Passive investing automatically tracking indexes now controls nearly half the US stock market." https://www.cnbc.com/2019/03/19/passive-investing-now-contro...

His graph shows an arrow pointed at the small sliver on ETFs, but that isn't necessarily the same as passive investing which would include a lot of mutual funds.

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

#85

Post by doubleunplussed »

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…

By symmetry, shouldn't the rapid growth of index funds imply the funds have paid inflated premiums to buy illiquid stocks? I suppose the 'bubble' claim is that they have, but that this is invisible because it has inflated the price of the underlying stocks as well so we still see the index funds priced the same as the underlying stocks.

At least for exchange-traded funds, it would seem that you don't have to actually destroy units of the ETF in the case of a sell-off. The ETF units would just sell at lower prices, just like when there is a 'sell off' of any stock - there are always equal numbers of buyers and sellers, you don't destroy units, you just move the price lower.

With index funds where you have an account directly with vanguard or whoever instead of buying units on an exchange, I'm not sure how it works in a sell-off. Perhaps they sell shares in the individual stocks, or perhaps they just try to sell off your shares bundled together by issuing more ETF units. I don't know what they do, but it seems like there are a bunch of options that should mean they don't have to sell off illiquid stocks on command.

I'm not sure. Happy to be enlightened. As much as I think about it, my intuition seems to consistently say that it's impossible for index funds to be broken in any meaningful way that's any different from the market itself or some sector thereof being in a bubble.

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

#86

Post by 8ytecoder »

david927 wrote: post #81

It doesn't seem silly at all. I agree with Michael Burry; I think passive investing is a bubble -- by definition. If you spent $10 million to make a cafe in your small hometown, you would never get that money back for the obvious reason that you could simply never sell that much coffee. The fundamentals aren't there. So if you invest in "all coffee shops" or "all shops in my hometown", you're not looking at fundament…

There are always active investors who could take advantage of this valuation mismatch and bet for/against specific companies that they think are undervalued/overvalued and make money. Eventually this valuation mismatch would show up in their P/L statement and balance sheet. Passive investing freeloads on active investors - in a sense. That's all it is and I for one think it's great.

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

#87

Post by gdubs »

david927 wrote: post #81

It doesn't seem silly at all. I agree with Michael Burry; I think passive investing is a bubble -- by definition. If you spent $10 million to make a cafe in your small hometown, you would never get that money back for the obvious reason that you could simply never sell that much coffee. The fundamentals aren't there. So if you invest in "all coffee shops" or "all shops in my hometown", you're not looking at fundament…

Investing in a whole sector isn’t any less of an investment. You still have to believe in coffee as something that will return in the long time. You’re just trading risk for softer returns than if you were to take a gamble on one specific shop.

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

#88

Post by lmm »

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?

> 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?

In any crisis, the people who get really screwed are those who decide they have to sell, at any price. Instant liquidity - by whichever route - gets really expensive. An actively managed fund can at least decide which assets to sell to meet redemptions, holding those it thinks are undervalued at the moment. Whereas an index fund is effectively exposed to a crisis anywhere in the market.

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

#90

Post by dumbfounder »

"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."

Have to take the rest of the article with several grains of salt after reading this. Even if the index was spread against all stocks it would have an impact. It implies that you can only move money around the market, not take it out of the market altogether.

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