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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 s

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 outperform index funds (https://www.cnbc.com/2019/03/15/active-fund-managers-trail-the-sp-500-for-the-ninth-year-in-a-row-in-triumph-for-indexing.html https://www.cnbc.com/2019/03/15/active-fund-managers-trail-t...), and so the managers of those funds in a strict sense don't earn their fees. So what is the average person with a couple bucks to invest supposed to take from this? The market is in peril because not enough money is flowing to people who do a poor job of managing it?

6thaccount2 7y ago
This is my question as well.
blankaccount 7y ago
The article is claiming that index funds are an overhyped bubble, so of course they'll out perform actively managed funds that have better liquidity.
- TimTheTinker 7y ago
  Perhaps they have become that because of their publicity. But when all the financial gurus are recommending investing in traditional securities (stocks and bonds), and millions of people wishing to get a leg up in life obey their advice, doesn't that turn the securities market in general into an "overhyped bubble"? The market behavior and health of any investment, no matter how theoretically sound it is, will be strongly affected by investors' behavior around it. So the fact that index funds are popular (and thus perhaps inflated/overpriced) isn't a knock on the fundamental idea. It's merely an indication of a particular market situation at present.
  - blankaccount 7y ago
    I agree, I saw below in someone else's comment that the issue is with the attitude of "[index] stocks will always go up in the long term", which is similar to the attitude "house prices always go up in the long term" which caused the 2008 crash.
    - randogogogo 7y ago
      This short explanation put the reasoning behind this in the best context for me, but makes me wonder more about the dissimilarities. Are there other factors like in the housing market of a decade+ ago? Is there a lot of risk for Joe Six-Pack? Are there people out there borrowing money from banks with poor underwriting practices getting into index funds when they should not be doing so? I'd think if this is most peoples' 401k and surplus income at risk that there may be a huge market correction but it won't devastate the economy. If people take the long term view and if investors sit tight and wait for the cycle to move into recovery again they'll be OK. If however they need to live off returns on their investments in the present (like homeowners needed a place to live during the crash) then they're in trouble.
      - WorldMaker 7y ago
        A lot of 401k providers have been pushing passive Index funds as "stable" late-life investments with higher return rates than actually stable securities such as bonds. So maybe there is a fear to find there that there is a lot more short term thinking and short-term investors in Index funds than there "should be" (and that market adjustment there could be disastrous to a lot of retirees).
        aledalgrande 7y ago
        Even basic investment courses, and any investment guru, will say any stock investment is not low risk enough if you need the money short term.
        7y ago
- markbnj 7y ago
  > so of course they'll out perform actively managed funds that have better liquidity I don't get this at all. So why aren't active fund managers investing in the same stocks the index funds are buying in order to take advantage of the price increase for their investors? Isn't that their job? And what do you mean by "better liquidity?"
- freewilly1040 7y ago
  Index funds aren't CDO's though, they are quite well established and their outperformance of active management goes back decades (IIUC).
beat 7y ago
The more interesting question is, if there is an index fund crash, will the actively managed funds benefit from it, or crash right alongside the index funds? How much are actively managed funds contaminated by stocks that are in index funds? (That probably depends on the type; a small-cap or emerging markets managed fund will probably be mostly clean of the indexed stocks, but a managed large-cap is probably full of them.)
- strstr 7y ago
  There’s a clear narrative in favor of actively managed funds: they analyze the underlying stock and avoid stocks that are overvalued according to their fundamentals, and buy those that are undervalued. The consequence would be near total avoidance of the S&P 500 as a good strategy for the long run. There would be exceptions for those stocks that are quite undervalued, or so overvalued that they are worth shorting (despite the tailwind of index funds). Don’t worry, strategies like these have predicted 12 out of the last 5 asset bubbles.
  - beat 7y ago
    Right. Which begs a question... are the large-cap stocks that dominate the index funds overvalued relative to their fundamentals? That should be easy enough to determine, and we should see a lot of "hold" or "sell" from the analysts. And if they're not overvalued, are index funds really a bubble?
    - jandrewrogers 7y ago
      The concept of "overvalued" assumes a valuation model that everyone agrees on. Large companies are complex organisms and equally complex to value. It follows, with ample evidence, that simple reductionist valuation models based on P/E, book value, and other easy-to-obtain numbers are going to be inadequate. And most valuation models are terrible at incorporating myriad risks. Currently, I would argue that some large caps are clearly overvalued but others are also clearly undervalued, based on my own valuation model. The indexes are almost always a mixed bag but I buy individual large caps so that doesn't concern me much. It is rare for the entire market to become overvalued, in which case the smart move is not to buy in.
0xcafecafe 7y ago
I think his point is that most index funds are weighted towards large caps and ignore small ones. With more and more money pouring in, it creates an inflation in value there whereas the small caps get ignored. That is the most logical interpretation I can draw out of his statement (although I am a 100% index investor myself).
- swsieber 7y ago
  Huh. I thought standard index fund advice was to split up you investments. I have 25% (of my investments) in a small cap fund. Does that count as ignored, or am I an outlier?
  - basch 7y ago
    A total market index fund is proportioned by market cap. As the large cap gets larger, it proportionally becomes a higher percent of the pie. If large cap is overvalued, youre owning less small cap than "true price market cap."
    - swsieber 7y ago
      Ah got it. So I by sharding my investment into several different different targeted funds (with auto-rebalancing) avoid that issue.... I think.
      - the_gastropod 7y ago
        You’re trading one issue for another. By holding x% of a small cap fund, where x does not equal the actual market proportion for small cap funds, you’re choosing to over or under weight that asset class.
      - basch 7y ago
        If, for example, you thought small caps were under valued, and you wanted to tilt small cap, you could keep doing exactly what youre doing, and just add a small investment into small caps on the side. So at Schwab, if you hold Schwab Target 2060 Index Fund (SWYNX) you can tilt by making sure Schwab U.S. Small-Cap ETF (SCHA) is 10% of your portfolio. At the moment, SCHA is 6.8% of SWYNX, so you would need an additional 3.2%. I dont know if you even need autobalancing for something so simple, just fix your allocation every time you make a contribution.
frgtpsswrdlame 7y ago
Well the argument, if I correctly understand, is that the less liquid stocks in index funds are getting pumped up because investor demand for passive stocks is outweighing active price discovery. This would exhibit a cyclical pattern where as passive outperformed, more investors switch over which continues to pump bad stocks and so on. Then in a downturn, even if you hold, as investors get scared and pull their cash out of the index fund, those less liquid stocks will get hammered by the double factor of their being already overvalued and also thinly traded, dragging passive performance way down. Not saying I agree but, if he's right it makes complete sense that passive would outperform active right now, just that in the next downturn it would dramatically underperform.
drelihan 7y ago
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 research, I'll just assume the market was able to price these accordingly and buy any cookie at the market price. At the beginning, it is great. They just sit back and buy baskets of cookies, some tasty, some meh... but they always pay the higher price for tasty and lower price for meh, so it is fair. Over time, more people start buying baskets of cookies rather than spending time/money figuring out what to pay for them. 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. Cookie manufactures notice this and figure might as well just make meh cookies as no one can tell the difference until after they buy them... and then we are stuck in a world with meh cookies. With some critical mass of active cookie investors, prices could be set fairly for all cookies. Too many active investors, and there is a drain on the system as there is likely a lot of duplicated work among the investors ( each one has to have a research team, back office cookie trading systems, etc, etc ). Too little and prices become less accurate.
- ninv 7y ago
  What i understood was all investors are buying basket of tasty cookies and no one is buying meh cookies' basket or cookies. So tasty cookies are overvalued and meh cookies are under valued.
  - kgwgk 7y ago
    "And now passive investing has removed price discovery from the [cookie] markets. The simple theses and the models that get people into [cookie baskets] -- these do not require the [cookie]-level analysis that is required for true price discovery."
    - woodandsteel 7y ago
      And the article says that is due to other factors in addition to passive investing, like central bank interest policies.
nabdab 7y ago
It’s all fine to say that active funds can’t outperform index funds... but if it’s a bubble and it crashes, then people in active funds will be having a field day while the people who bet it all on index funds will be left behind like the people who leveraged their 3 homes to buy 5 more during the “real estate always and consistently goes up” days of pre 2008. The problem with bubbles is that everyone’s a winner and every indicator is confirming the everlasting increase.. on the way up.
- edmundsauto 7y ago
  This would assume that active funds exit at the right point in the crash. What if they wait to the bottom to sell? What if they sell during a temporary dip, then the market rallies (pseudo-bubble that never happens?)
- markbnj 7y ago
  > It’s all fine to say that active funds can’t outperform index funds... but if it’s a bubble and it crashes, then people in active funds will be having a field day The CNBC article I linked claims that actively managed funds have been beaten by the S&P 500 for _nine straight years_. How long do the investors in actively managed funds have to wait for their big celebration?
ptero 7y ago
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: individuals easily move through doors at will; but if a crowd rushes out through the same door, injuries happen. His premise is that many stocks that index funds invest in have low liquidity (small door): half of stocks in SP500 trades less than $150M a day. This is tiny (he quotes total market cap of indices of $150 trillion). What happens if there is a small, but synchronized outflow for any reason? 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. Which is a problem, as there may be no one to sell them to, so prices of those stocks may crash and create a big panic causing additional sales of index funds bringing down bigger chunks of the market. That is the gist of it I think.
- entee 7y ago
  So the result would then be something like the flash crash? I share your understanding of the article, it’s not about “index bad active good”, it’s about, “is there a problem when a lot of investors have to move quickly”. I wonder if there is some analysis of this during the last crash.
  - ptero 7y ago
    It could be more serious than the flash crash (again, just an interpretation). Flash crash gets resolved quickly and is transparent to non-participants because there is a lot of money willing to buy on dips. But fast trading money only buys and sells what they perceive to be highly liquid assets -- there are few things that scare them more than being stuck with an open trade. The scenario Burry describes is akin to CDO crash. Naively, most CDO assets were not problematic and many/most of the problem ones had an underlying asset of some value guaranteeing the debt. What caused the crash was lack of liquidity that started a vicious circle. Index fund scenario could be similar: less liquid stocks that are big components of major indices would crash with unknown systematic consequences. Even if only 10% of passive index investors heads for the exits we could see broad, long term damage. And they could: pension funds have been investing huge sums into indices and a targeted PR / a few headlines of the type "look what those financiers doing with worker's money" may nudge a lot of money out of stocks. On the other side, it is easy to make conspiracy theories on any subject.
colechristensen 7y ago
The market is in peril because there are too few actors setting value based on the merits of the company instead of betting on other investors' behavior. You want to help? Pull some, not all but some assets out of index funds and put them into individual companies you understand and believe have long term profitability. Sell those assets when you think they're overvalued by the market. Trading less often is correlated with better performance (you are not an HFT) There is some responsibility you have. Your money isn't going to just magically work for you, you have some obligation to research and understand what you are investing in. When nobody does it, the market is in trouble.
- human20190310 7y ago
  > put [your money] into individual companies you understand and believe have long term profitability If anyone was able to do this, they'd be a successful money manager themselves. Yet few professionals actually manage to do this at all, let alone sufficiently to justify their fees, which is why index-fund investing is so popular in the first place. The only real way to reduce the reliance on index funds is for professional investment services to become sufficiently competent that it makes sense to use their services. Asking the average person to "take one for the team" and throw their dart at the same dartboard the pros can't even hit isn't a great solution. [EDIT: phrasing]
  - kd5bjo 7y ago
    There’s a lot more that goes into the success of a business than the financials that investment services firms have access to. It’s entirely possible for someone that interacts with a company on a daily or weekly basis to have a better idea of how well that business is doing than professional investors, especially if they also bother to look at the public financials. Gathering this kind of information may be too labor-intensive to justify doing it as a profession but rewarding enough for an interested amateur.
  - repolfx 7y ago
    That assumes it's possible to retain a deep understanding of a company or industry whilst being outside of and focusing full time on "money management". It's the same school of thought that says corporate management is a generic skill that people can/should be taught and then they can manage anything.
charwalker 7y ago
There is an interesting idea when index funds are taken to an extreme in that if no one is manually playing the market or managing investments then everything is invested in at the same or similar rates. Index funds need active traders to trade and set pricing within the market. My analogy would be if we are all buying tickets to the big game and sit in the stands until it's over, there's no one to yell and shout and drive the energy of the crown or possibly no one to even compete on the field therefore why are we even showing up? It's definitely the extreme - active trading isn't going away any time soon but fears of a only a limited group playing the market and managing or controlling stock prices for their gain isn't 100% unrealistic.
- pas 7y ago
  But the wisdom of the crowd, the price signal, only works if professionals look at the stocks. And it requires only a few [hundred] of them (with big enough leverage, so their position shows up). For the top 500 stocks there are enough people (and algos) going over every bit released by the corresponding companies.
  - repolfx 7y ago
    That's a contradiction. It's not the wisdom of the crowds if only a few hundred people are really looking at things. The whole point of that expression is that you need a crowd, to avoid groupthink, capture etc
    - pas 7y ago
      Not really, because passive funds just piggy-back on the price finding results of the market. And the active market is very sensitive. Especially if someone is so confident that they are willing to use drastically leveraged positions.
throw0101a 7y ago
> 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 evidence shows that most of us suck at investing. Further, I think Burry's critique is more limited: > One reason he likes small-cap value stocks: they tend to be under-represented in passive funds. IMHO, the problem he's stating is that people are focusing on large-cap companies. Basically the S&P500. And the S&P500 index funds probably do hold most of the passively invested money. But to solve this (small- vs large-cap focus), the solution is not to throw away passive investing, but to change the focus. For example, instead of buying Vanguard's S&P500 fund (VOO), to buy their Total Market fund (VTI) which uses the CRSP U.S. Total Market Index: * https://en.wikipedia.org/wiki/Center_for_Research_in_Security_Prices https://en.wikipedia.org/wiki/Center_for_Research_in_Securit... Or perhaps a fund that uses the the Russell 3000 or Wilshire 5000. * https://en.wikipedia.org/wiki/Russell_3000_Index https://en.wikipedia.org/wiki/Russell_3000_Index * https://en.wikipedia.org/wiki/Wilshire_5000 https://en.wikipedia.org/wiki/Wilshire_5000 It's just that the S&P (and DOW) have more name recognition. But generally speaking, these decisions are micro-optimizations. Just put away a little every month and re-invest and dividends, and over the long-term you'll do well.
- freewilly1040 7y ago
  He's saying index funds are invested in companies big enough to be indexed, but too small for the stocks to remain liquid in a market with a lot of sellers. By this reasoning indexes focussing on small caps would be even worse than the more popular funds.
sailfast 7y ago
The point of the article for me is that all of this capital in one place is bad for contagion, and there’s no backstop to even small fluctuations downward / sell-offs that will end up zeroing out the wealth of most index investors. In that way it resembles all the capital in CDOs - but this time instead of being held by banks that can get bailed out it’s being held by individuals. Woof. Bottom line - they look low risk until they’re absolutely not low risk because of these properties. As an average investor I’d say diversify is still a good strategy. Don’t just do US Market index funds. Global stocks, bonds, and other small-cap stock collections might help hedge risk of large-caps going bust. Most passive-style funds also have these options. Not an active investor. Just a dude playing a dude disguised as another dude. This is not investment advice.
deleted 7y ago
[deleted]

6thaccount2 7y ago

This is my question as well.

blankaccount 7y ago

The article is claiming that index funds are an overhyped bubble, so of course they'll out perform actively managed funds that have better liquidity.

TimTheTinker 7y ago
Perhaps they have become that because of their publicity. But when all the financial gurus are recommending investing in traditional securities (stocks and bonds), and millions of people wishing to get a leg up in life obey their advice, doesn't that turn the securities market in general into an "overhyped bubble"? The market behavior and health of any investment, no matter how theoretically sound it is, will be strongly affected by investors' behavior around it. So the fact that index funds are popular (and thus perhaps inflated/overpriced) isn't a knock on the fundamental idea. It's merely an indication of a particular market situation at present.
- blankaccount 7y ago
  I agree, I saw below in someone else's comment that the issue is with the attitude of "[index] stocks will always go up in the long term", which is similar to the attitude "house prices always go up in the long term" which caused the 2008 crash.
  - randogogogo 7y ago
    This short explanation put the reasoning behind this in the best context for me, but makes me wonder more about the dissimilarities. Are there other factors like in the housing market of a decade+ ago? Is there a lot of risk for Joe Six-Pack? Are there people out there borrowing money from banks with poor underwriting practices getting into index funds when they should not be doing so? I'd think if this is most peoples' 401k and surplus income at risk that there may be a huge market correction but it won't devastate the economy. If people take the long term view and if investors sit tight and wait for the cycle to move into recovery again they'll be OK. If however they need to live off returns on their investments in the present (like homeowners needed a place to live during the crash) then they're in trouble.
    - WorldMaker 7y ago
      A lot of 401k providers have been pushing passive Index funds as "stable" late-life investments with higher return rates than actually stable securities such as bonds. So maybe there is a fear to find there that there is a lot more short term thinking and short-term investors in Index funds than there "should be" (and that market adjustment there could be disastrous to a lot of retirees).
      - aledalgrande 7y ago
        Even basic investment courses, and any investment guru, will say any stock investment is not low risk enough if you need the money short term.
        7y ago
markbnj 7y ago
> so of course they'll out perform actively managed funds that have better liquidity I don't get this at all. So why aren't active fund managers investing in the same stocks the index funds are buying in order to take advantage of the price increase for their investors? Isn't that their job? And what do you mean by "better liquidity?"
freewilly1040 7y ago
Index funds aren't CDO's though, they are quite well established and their outperformance of active management goes back decades (IIUC).

beat 7y ago

The more interesting question is, if there is an index fund crash, will the actively managed funds benefit from it, or crash right alongside the index funds? How much are actively managed funds contaminated by stocks that are in index funds? (That probably depends on the type; a small-cap or emerging markets managed fund will probably be mostly clean of the indexed stocks, but a managed large-cap is probably full of them.)

strstr 7y ago
There’s a clear narrative in favor of actively managed funds: they analyze the underlying stock and avoid stocks that are overvalued according to their fundamentals, and buy those that are undervalued. The consequence would be near total avoidance of the S&P 500 as a good strategy for the long run. There would be exceptions for those stocks that are quite undervalued, or so overvalued that they are worth shorting (despite the tailwind of index funds). Don’t worry, strategies like these have predicted 12 out of the last 5 asset bubbles.
- beat 7y ago
  Right. Which begs a question... are the large-cap stocks that dominate the index funds overvalued relative to their fundamentals? That should be easy enough to determine, and we should see a lot of "hold" or "sell" from the analysts. And if they're not overvalued, are index funds really a bubble?
  - jandrewrogers 7y ago
    The concept of "overvalued" assumes a valuation model that everyone agrees on. Large companies are complex organisms and equally complex to value. It follows, with ample evidence, that simple reductionist valuation models based on P/E, book value, and other easy-to-obtain numbers are going to be inadequate. And most valuation models are terrible at incorporating myriad risks. Currently, I would argue that some large caps are clearly overvalued but others are also clearly undervalued, based on my own valuation model. The indexes are almost always a mixed bag but I buy individual large caps so that doesn't concern me much. It is rare for the entire market to become overvalued, in which case the smart move is not to buy in.

0xcafecafe 7y ago

I think his point is that most index funds are weighted towards large caps and ignore small ones. With more and more money pouring in, it creates an inflation in value there whereas the small caps get ignored. That is the most logical interpretation I can draw out of his statement (although I am a 100% index investor myself).

swsieber 7y ago
Huh. I thought standard index fund advice was to split up you investments. I have 25% (of my investments) in a small cap fund. Does that count as ignored, or am I an outlier?
- basch 7y ago
  A total market index fund is proportioned by market cap. As the large cap gets larger, it proportionally becomes a higher percent of the pie. If large cap is overvalued, youre owning less small cap than "true price market cap."
  - swsieber 7y ago
    Ah got it. So I by sharding my investment into several different different targeted funds (with auto-rebalancing) avoid that issue.... I think.
    - the_gastropod 7y ago
      You’re trading one issue for another. By holding x% of a small cap fund, where x does not equal the actual market proportion for small cap funds, you’re choosing to over or under weight that asset class.
    - basch 7y ago
      If, for example, you thought small caps were under valued, and you wanted to tilt small cap, you could keep doing exactly what youre doing, and just add a small investment into small caps on the side. So at Schwab, if you hold Schwab Target 2060 Index Fund (SWYNX) you can tilt by making sure Schwab U.S. Small-Cap ETF (SCHA) is 10% of your portfolio. At the moment, SCHA is 6.8% of SWYNX, so you would need an additional 3.2%. I dont know if you even need autobalancing for something so simple, just fix your allocation every time you make a contribution.

frgtpsswrdlame 7y ago

Well the argument, if I correctly understand, is that the less liquid stocks in index funds are getting pumped up because investor demand for passive stocks is outweighing active price discovery. This would exhibit a cyclical pattern where as passive outperformed, more investors switch over which continues to pump bad stocks and so on. Then in a downturn, even if you hold, as investors get scared and pull their cash out of the index fund, those less liquid stocks will get hammered by the double factor of their being already overvalued and also thinly traded, dragging passive performance way down. Not saying I agree but, if he's right it makes complete sense that passive would outperform active right now, just that in the next downturn it would dramatically underperform.

drelihan 7y ago

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 research, I'll just assume the market was able to price these accordingly and buy any cookie at the market price. At the beginning, it is great. They just sit back and buy baskets of cookies, some tasty, some meh... but they always pay the higher price for tasty and lower price for meh, so it is fair. Over time, more people start buying baskets of cookies rather than spending time/money figuring out what to pay for them. 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. Cookie manufactures notice this and figure might as well just make meh cookies as no one can tell the difference until after they buy them... and then we are stuck in a world with meh cookies. With some critical mass of active cookie investors, prices could be set fairly for all cookies. Too many active investors, and there is a drain on the system as there is likely a lot of duplicated work among the investors ( each one has to have a research team, back office cookie trading systems, etc, etc ). Too little and prices become less accurate.

ninv 7y ago
What i understood was all investors are buying basket of tasty cookies and no one is buying meh cookies' basket or cookies. So tasty cookies are overvalued and meh cookies are under valued.
- kgwgk 7y ago
  "And now passive investing has removed price discovery from the [cookie] markets. The simple theses and the models that get people into [cookie baskets] -- these do not require the [cookie]-level analysis that is required for true price discovery."
  - woodandsteel 7y ago
    And the article says that is due to other factors in addition to passive investing, like central bank interest policies.

nabdab 7y ago

It’s all fine to say that active funds can’t outperform index funds... but if it’s a bubble and it crashes, then people in active funds will be having a field day while the people who bet it all on index funds will be left behind like the people who leveraged their 3 homes to buy 5 more during the “real estate always and consistently goes up” days of pre 2008. The problem with bubbles is that everyone’s a winner and every indicator is confirming the everlasting increase.. on the way up.

edmundsauto 7y ago
This would assume that active funds exit at the right point in the crash. What if they wait to the bottom to sell? What if they sell during a temporary dip, then the market rallies (pseudo-bubble that never happens?)
markbnj 7y ago
> It’s all fine to say that active funds can’t outperform index funds... but if it’s a bubble and it crashes, then people in active funds will be having a field day The CNBC article I linked claims that actively managed funds have been beaten by the S&P 500 for _nine straight years_. How long do the investors in actively managed funds have to wait for their big celebration?

ptero 7y ago

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: individuals easily move through doors at will; but if a crowd rushes out through the same door, injuries happen. His premise is that many stocks that index funds invest in have low liquidity (small door): half of stocks in SP500 trades less than $150M a day. This is tiny (he quotes total market cap of indices of $150 trillion). What happens if there is a small, but synchronized outflow for any reason? 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. Which is a problem, as there may be no one to sell them to, so prices of those stocks may crash and create a big panic causing additional sales of index funds bringing down bigger chunks of the market. That is the gist of it I think.

entee 7y ago
So the result would then be something like the flash crash? I share your understanding of the article, it’s not about “index bad active good”, it’s about, “is there a problem when a lot of investors have to move quickly”. I wonder if there is some analysis of this during the last crash.
- ptero 7y ago
  It could be more serious than the flash crash (again, just an interpretation). Flash crash gets resolved quickly and is transparent to non-participants because there is a lot of money willing to buy on dips. But fast trading money only buys and sells what they perceive to be highly liquid assets -- there are few things that scare them more than being stuck with an open trade. The scenario Burry describes is akin to CDO crash. Naively, most CDO assets were not problematic and many/most of the problem ones had an underlying asset of some value guaranteeing the debt. What caused the crash was lack of liquidity that started a vicious circle. Index fund scenario could be similar: less liquid stocks that are big components of major indices would crash with unknown systematic consequences. Even if only 10% of passive index investors heads for the exits we could see broad, long term damage. And they could: pension funds have been investing huge sums into indices and a targeted PR / a few headlines of the type "look what those financiers doing with worker's money" may nudge a lot of money out of stocks. On the other side, it is easy to make conspiracy theories on any subject.

colechristensen 7y ago

The market is in peril because there are too few actors setting value based on the merits of the company instead of betting on other investors' behavior. You want to help? Pull some, not all but some assets out of index funds and put them into individual companies you understand and believe have long term profitability. Sell those assets when you think they're overvalued by the market. Trading less often is correlated with better performance (you are not an HFT) There is some responsibility you have. Your money isn't going to just magically work for you, you have some obligation to research and understand what you are investing in. When nobody does it, the market is in trouble.

human20190310 7y ago
> put [your money] into individual companies you understand and believe have long term profitability If anyone was able to do this, they'd be a successful money manager themselves. Yet few professionals actually manage to do this at all, let alone sufficiently to justify their fees, which is why index-fund investing is so popular in the first place. The only real way to reduce the reliance on index funds is for professional investment services to become sufficiently competent that it makes sense to use their services. Asking the average person to "take one for the team" and throw their dart at the same dartboard the pros can't even hit isn't a great solution. [EDIT: phrasing]
- kd5bjo 7y ago
  There’s a lot more that goes into the success of a business than the financials that investment services firms have access to. It’s entirely possible for someone that interacts with a company on a daily or weekly basis to have a better idea of how well that business is doing than professional investors, especially if they also bother to look at the public financials. Gathering this kind of information may be too labor-intensive to justify doing it as a profession but rewarding enough for an interested amateur.
- repolfx 7y ago
  That assumes it's possible to retain a deep understanding of a company or industry whilst being outside of and focusing full time on "money management". It's the same school of thought that says corporate management is a generic skill that people can/should be taught and then they can manage anything.

charwalker 7y ago

There is an interesting idea when index funds are taken to an extreme in that if no one is manually playing the market or managing investments then everything is invested in at the same or similar rates. Index funds need active traders to trade and set pricing within the market. My analogy would be if we are all buying tickets to the big game and sit in the stands until it's over, there's no one to yell and shout and drive the energy of the crown or possibly no one to even compete on the field therefore why are we even showing up? It's definitely the extreme - active trading isn't going away any time soon but fears of a only a limited group playing the market and managing or controlling stock prices for their gain isn't 100% unrealistic.

pas 7y ago
But the wisdom of the crowd, the price signal, only works if professionals look at the stocks. And it requires only a few [hundred] of them (with big enough leverage, so their position shows up). For the top 500 stocks there are enough people (and algos) going over every bit released by the corresponding companies.
- repolfx 7y ago
  That's a contradiction. It's not the wisdom of the crowds if only a few hundred people are really looking at things. The whole point of that expression is that you need a crowd, to avoid groupthink, capture etc
  - pas 7y ago
    Not really, because passive funds just piggy-back on the price finding results of the market. And the active market is very sensitive. Especially if someone is so confident that they are willing to use drastically leveraged positions.

throw0101a 7y ago

> 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 evidence shows that most of us suck at investing. Further, I think Burry's critique is more limited: > One reason he likes small-cap value stocks: they tend to be under-represented in passive funds. IMHO, the problem he's stating is that people are focusing on large-cap companies. Basically the S&P500. And the S&P500 index funds probably do hold most of the passively invested money. But to solve this (small- vs large-cap focus), the solution is not to throw away passive investing, but to change the focus. For example, instead of buying Vanguard's S&P500 fund (VOO), to buy their Total Market fund (VTI) which uses the CRSP U.S. Total Market Index: * https://en.wikipedia.org/wiki/Center_for_Research_in_Security_Prices https://en.wikipedia.org/wiki/Center_for_Research_in_Securit... Or perhaps a fund that uses the the Russell 3000 or Wilshire 5000. * https://en.wikipedia.org/wiki/Russell_3000_Index https://en.wikipedia.org/wiki/Russell_3000_Index * https://en.wikipedia.org/wiki/Wilshire_5000 https://en.wikipedia.org/wiki/Wilshire_5000 It's just that the S&P (and DOW) have more name recognition. But generally speaking, these decisions are micro-optimizations. Just put away a little every month and re-invest and dividends, and over the long-term you'll do well.

freewilly1040 7y ago
He's saying index funds are invested in companies big enough to be indexed, but too small for the stocks to remain liquid in a market with a lot of sellers. By this reasoning indexes focussing on small caps would be even worse than the more popular funds.

sailfast 7y ago

The point of the article for me is that all of this capital in one place is bad for contagion, and there’s no backstop to even small fluctuations downward / sell-offs that will end up zeroing out the wealth of most index investors. In that way it resembles all the capital in CDOs - but this time instead of being held by banks that can get bailed out it’s being held by individuals. Woof. Bottom line - they look low risk until they’re absolutely not low risk because of these properties. As an average investor I’d say diversify is still a good strategy. Don’t just do US Market index funds. Global stocks, bonds, and other small-cap stock collections might help hedge risk of large-caps going bust. Most passive-style funds also have these options. Not an active investor. Just a dude playing a dude disguised as another dude. This is not investment advice.

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