6 ms·

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.

by sambe 7y ago

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.

bwanab 7y ago
Right, but consider that the sub-prime mortgage market was a tiny portion of the overall mortgage market in 2007. Derivatives written against sub-prime holdings tipped the balance when the fan was hit. There are tons of derivatives written against the indices, thus indirectly against those funds.
- AnimalMuppet 7y ago
  No, not against those funds. Pass a royal decree that banishes all index funds from the face of the earth. The tons of derivatives written against the indices remain, unchanged. Those derivatives might be "somewhat in the neighborhood of the funds" or something, but it's not analogous to mortgages.
- navigatesol 7y ago
  >Derivatives written against sub-prime holdings tipped the balance when the fan was hit There's a bit more nuance to it: those derivatives were a problem because a substantial proportion of them were concentrated in a single, widely-connected, entity (AIG). The derivative market as a whole nets to zero; for every loser there is a winner.
- turk73 7y ago
  There was the little problem of how sub-prime debt got whitewashed and turned into Aaa rated paper by the ratings agencies. All those sub-prime tranches, had they been correctly rated, would not have had such a magnifying effect. It was because of packaged bonds containing multiple tranches that couldn't be priced at anything but $0. Also, the interest bearing portions of loans were split into different bonds, further complicating matters. There wasn't (and still isn't) a mark-to-market in bonds. Many bonds aren't priced until bought/sold, e.g. illiquid.
dcolkitt 7y ago
> "Liquidity is not a huge problem for index funds" -no market impact to sell (v dubious if you ask me), unlevered. If you're talking about index mutual funds, then the author is just plain wrong. Any open-ended fund offering daily liquidity will trade, and therefore produce market impact, to meet its daily redemptions. If you're only talking about ETFs, then this is technically correct. Besides the occasional index re-constitution, unlevered index ETFs don't do any trading. However it's definitely not true that there's no market impact. As the fund grows (or shrinks) the shares just don't magically appear in the portfolio. Somebody has to go out and buy (or sell) those shares, and like any trading volume, that creates market impact. The mechanism that ETFs actually use is something called "Authorized Participants" (or APs for short). Basically market makers have the right to create or redeem shares in the ETF. To create new shares, they go out and buy all the stocks in the index, then hand a basket over to the ETF fund manager, who then hands back new shares of the equivalent value. And to destroy shares, the AP hand over shares in the ETF, and the fund manager hands back a basket of shares from the index. If there's high demand for investors to own the ETF, that'll push up the ETF's stock price. As the price rises relative to the index value, APs will detect an arbitrage opportunity. They'll go out and buy the basket of stocks in the index at a cheaper price, then create new ETF shares at the richer price, and pocket the difference. Vice versa if there's demand from investors to exit the ETF. The mechanism keeps the ETF price closely pegged to the index, because the further out of line it gets the more arbitrageur activity pushes it back in line. While also flexibly satisfying investors' specific demand for the ETF at any given time. Basically it delegates the role of trading from the fund manager, who usually doesn't have any special expertise in trading, to highly specialized trading firms and market makers. However, as you can clearly see, market impact most definitely exists. If a flurry of investors rush to enter or exit an ETF, then a huge amount of trading has to be done to create or redeem the shares. Just because the APs create this trading impact, instead of the fund itself, is a distinction without a difference. The underlying stocks in the index are subject to market impact.
- navigatesol 7y ago
  >If a flurry of investors rush to enter or exit an ETF, then a huge amount of trading has to be done to create or redeem the shares. Just because the APs create this trading impact, instead of the fund itself, is a distinction without a difference. The underlying stocks in the index are subject to market impact. But the trading isn't the cause of the market impact, it's the redemptions that occur first, and force the trading. There had to have been economic or financial reasons for those redemptions to occur. The fact that when everyone tries to sell at one, there's aren't enough buyers is a story of the ages. That ETFs will suffer the same consequences in a run is hardly unique to them as financial assets.
panarky 7y ago
Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done. (John Maynard Keynes, General Theory, Chapter 12, page 142 in the Google Book edition)
talolard 7y ago
I think they talk about it but didn't add up to a rebuttal or challenge of Burry's liquidity point. < I think they claim is that their is a lot of "dumb money" holding indexed products that are likely to sell all at once when things turn south. By the structure of these funds, their will be large selling pressure on the underlying stocks and a good chunk of them don't have the liquidity to support that pressure. That doesn't mean their will be a metldown, just that prices will tank very hard and a lot of people will lose a lot of money + the economic effects that has I don't understand. I was hoping the original article would tear that reasoning down, and while it did touch on various mechanisms it didn't give a cohesive thesis as to why that is wrong.
- throw0101a 7y ago
  > I think they claim is that their is a lot of "dumb money" holding indexed products that are likely to sell all at once when things turn south. There is no evidence for this. During the 2000-2002 and 2008-2009 index funds actually saw higher inflows: * https://www.etfstrategy.com/three-reasons-why-indexing-and-etfs-wont-cause-the-next-market-crash-10448/ https://www.etfstrategy.com/three-reasons-why-indexing-and-e...
- fyz 7y ago
  What would said dumb money be holding if not index funds? Single name blue chips? What would the blue chip holders do in the counterfactual world where there is a big downturn? Perhaps there will be greater correlation between names in a downturn, but then again, factor-based investing might offset some of that.
walshemj 7y ago
Liquidity can be a very serious problem for open ended funds and they have to keep cash on had to meet redemptions unlike closed ended funds like investment trusts.
- wcoenen 7y ago
  Why would cash be involved for an ETF redemption? Doesn't the ETF manager just hand over the underlying securities?
  - Expez 7y ago
    No, it's cash in and cash out. That's the entire point of an ETF, that it's very easy to buy and sell yet still tracking something complex. Imagine if you'd invested in the Russel 3000 index, which aims at tracking the entire US stock market. If the ETF manager transferred the securities as you exited you'd now have to manually sell 3000 securities across many markets. The ETF has tools and processes for this, you don't. You pay them a fee for the convenience of not having to deal with the underlying assets. Another example would be something like the iShares gold or iShares silver ETF. They hold precious metals in a secure vault on your behalf, for a fee. You probably don't want a delivery from an armored truck every time you exit the ETF! :)
    - wcoenen 7y ago
      ETFs are trade on exchanges for cash, but the fund manager is not involved in that. You simply sell your ETF shares to another buyer. Redemptions are something different that only "authorized participants" can do, and as far as I know the ETF share is traded (or actually destroyed) for the underlying securities in that case. https://www.investopedia.com/terms/r/redemption-mechanism.asp https://www.investopedia.com/terms/r/redemption-mechanism.as...

by sambe 7y ago

bwanab 7y ago

Right, but consider that the sub-prime mortgage market was a tiny portion of the overall mortgage market in 2007. Derivatives written against sub-prime holdings tipped the balance when the fan was hit. There are tons of derivatives written against the indices, thus indirectly against those funds.

AnimalMuppet 7y ago
No, not against those funds. Pass a royal decree that banishes all index funds from the face of the earth. The tons of derivatives written against the indices remain, unchanged. Those derivatives might be "somewhat in the neighborhood of the funds" or something, but it's not analogous to mortgages.
navigatesol 7y ago
>Derivatives written against sub-prime holdings tipped the balance when the fan was hit There's a bit more nuance to it: those derivatives were a problem because a substantial proportion of them were concentrated in a single, widely-connected, entity (AIG). The derivative market as a whole nets to zero; for every loser there is a winner.
turk73 7y ago
There was the little problem of how sub-prime debt got whitewashed and turned into Aaa rated paper by the ratings agencies. All those sub-prime tranches, had they been correctly rated, would not have had such a magnifying effect. It was because of packaged bonds containing multiple tranches that couldn't be priced at anything but $0. Also, the interest bearing portions of loans were split into different bonds, further complicating matters. There wasn't (and still isn't) a mark-to-market in bonds. Many bonds aren't priced until bought/sold, e.g. illiquid.

dcolkitt 7y ago

> "Liquidity is not a huge problem for index funds" -no market impact to sell (v dubious if you ask me), unlevered. If you're talking about index mutual funds, then the author is just plain wrong. Any open-ended fund offering daily liquidity will trade, and therefore produce market impact, to meet its daily redemptions. If you're only talking about ETFs, then this is technically correct. Besides the occasional index re-constitution, unlevered index ETFs don't do any trading. However it's definitely not true that there's no market impact. As the fund grows (or shrinks) the shares just don't magically appear in the portfolio. Somebody has to go out and buy (or sell) those shares, and like any trading volume, that creates market impact. The mechanism that ETFs actually use is something called "Authorized Participants" (or APs for short). Basically market makers have the right to create or redeem shares in the ETF. To create new shares, they go out and buy all the stocks in the index, then hand a basket over to the ETF fund manager, who then hands back new shares of the equivalent value. And to destroy shares, the AP hand over shares in the ETF, and the fund manager hands back a basket of shares from the index. If there's high demand for investors to own the ETF, that'll push up the ETF's stock price. As the price rises relative to the index value, APs will detect an arbitrage opportunity. They'll go out and buy the basket of stocks in the index at a cheaper price, then create new ETF shares at the richer price, and pocket the difference. Vice versa if there's demand from investors to exit the ETF. The mechanism keeps the ETF price closely pegged to the index, because the further out of line it gets the more arbitrageur activity pushes it back in line. While also flexibly satisfying investors' specific demand for the ETF at any given time. Basically it delegates the role of trading from the fund manager, who usually doesn't have any special expertise in trading, to highly specialized trading firms and market makers. However, as you can clearly see, market impact most definitely exists. If a flurry of investors rush to enter or exit an ETF, then a huge amount of trading has to be done to create or redeem the shares. Just because the APs create this trading impact, instead of the fund itself, is a distinction without a difference. The underlying stocks in the index are subject to market impact.

navigatesol 7y ago
>If a flurry of investors rush to enter or exit an ETF, then a huge amount of trading has to be done to create or redeem the shares. Just because the APs create this trading impact, instead of the fund itself, is a distinction without a difference. The underlying stocks in the index are subject to market impact. But the trading isn't the cause of the market impact, it's the redemptions that occur first, and force the trading. There had to have been economic or financial reasons for those redemptions to occur. The fact that when everyone tries to sell at one, there's aren't enough buyers is a story of the ages. That ETFs will suffer the same consequences in a run is hardly unique to them as financial assets.

panarky 7y ago

Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done. (John Maynard Keynes, General Theory, Chapter 12, page 142 in the Google Book edition)

talolard 7y ago

I think they talk about it but didn't add up to a rebuttal or challenge of Burry's liquidity point. < I think they claim is that their is a lot of "dumb money" holding indexed products that are likely to sell all at once when things turn south. By the structure of these funds, their will be large selling pressure on the underlying stocks and a good chunk of them don't have the liquidity to support that pressure. That doesn't mean their will be a metldown, just that prices will tank very hard and a lot of people will lose a lot of money + the economic effects that has I don't understand. I was hoping the original article would tear that reasoning down, and while it did touch on various mechanisms it didn't give a cohesive thesis as to why that is wrong.

throw0101a 7y ago
> I think they claim is that their is a lot of "dumb money" holding indexed products that are likely to sell all at once when things turn south. There is no evidence for this. During the 2000-2002 and 2008-2009 index funds actually saw higher inflows: * https://www.etfstrategy.com/three-reasons-why-indexing-and-etfs-wont-cause-the-next-market-crash-10448/ https://www.etfstrategy.com/three-reasons-why-indexing-and-e...
fyz 7y ago
What would said dumb money be holding if not index funds? Single name blue chips? What would the blue chip holders do in the counterfactual world where there is a big downturn? Perhaps there will be greater correlation between names in a downturn, but then again, factor-based investing might offset some of that.

walshemj 7y ago

Liquidity can be a very serious problem for open ended funds and they have to keep cash on had to meet redemptions unlike closed ended funds like investment trusts.

wcoenen 7y ago
Why would cash be involved for an ETF redemption? Doesn't the ETF manager just hand over the underlying securities?
- Expez 7y ago
  No, it's cash in and cash out. That's the entire point of an ETF, that it's very easy to buy and sell yet still tracking something complex. Imagine if you'd invested in the Russel 3000 index, which aims at tracking the entire US stock market. If the ETF manager transferred the securities as you exited you'd now have to manually sell 3000 securities across many markets. The ETF has tools and processes for this, you don't. You pay them a fee for the convenience of not having to deal with the underlying assets. Another example would be something like the iShares gold or iShares silver ETF. They hold precious metals in a secure vault on your behalf, for a fee. You probably don't want a delivery from an armored truck every time you exit the ETF! :)
  - wcoenen 7y ago
    ETFs are trade on exchanges for cash, but the fund manager is not involved in that. You simply sell your ETF shares to another buyer. Redemptions are something different that only "authorized participants" can do, and as far as I know the ETF share is traded (or actually destroyed) for the underlying securities in that case. https://www.investopedia.com/terms/r/redemption-mechanism.asp https://www.investopedia.com/terms/r/redemption-mechanism.as...