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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 d

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 immediately cause a problem for investors who don't sell (price is not value), the newly discount-price firms may struggle immensely in terms of raising new capital and financing.

FabHK 7y ago
> 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".)
- OJFord 7y ago
  > 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 His argument there AIUI was that the daily volume is not in proportion.
  - FabHK 7y ago
    Fair enough, so going back to a liquidity mismatch. Will be interesting to watch the next market crash.
omgwtfbyobbq 7y ago
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/Annotation-2019-09-04-220027.jpg https://awealthofcommonsense.com/wp-content/uploads/2019/09/...
- mcguire 7y ago
  I think the point you want to make is that we've never had a market correction with the number of investors at current levels is accurate.
intuitionist 7y ago
There are also a lot more liquidity providers than there were in the past, no? I know there are concerns that the high-frequency traders will turn off the computers in a crash, but if the index funds have to sell their small holdings at a deep discount, that’s an opportunity for someone to step in and buy them on the cheap. I guess there are more legitimate concerns for funds that hold bonds or real estate or other less-liquid assets. But the solution to that is just, don’t put yourself in a position where you have to liquidate those funds in a crunch.
- rocqua 7y ago
  The high frequency traders I know of are market makers. They want to make money by buying and immediately selling stock. Earning a spread, but never having an actual position. For them, the prospect of holding a stock that is undervalued by 10% for a few days is not good. Other forms of algorithmic trading might still step in though.
thanatropism 7y ago
The title is terrible. The fundamental problem he seems to be pointing at is that notional replicating portfolios can work like an engineering marvel in good times and become inoperable in bad (liquidity) times. There were many elements to the CDO crisis -- including bad faith by the rating agencies and a prolonged asset-price mania much beyond this stock-market rally. The simpler metaphor is the emission of vanilla stock options. In principle, a bank is only able to offer options because he has the ability to replicate it and neutralize his risk. But if market conditions diverge from the asset replication model, then boom you get LTCM.
- notyourday 7y ago
  > The fundamental problem he seems to be pointing at is that notional replicating portfolios can work like an engineering marvel in good times and become inoperable in bad (liquidity) times. He is confused. That was the problem with the synthetic OTC instruments that he used which nearly tripped his winning position because no one wanted to actually trade with them. And even that was largely the case because he was buying not even CDOs but synthetic instruments that were derivatives of the CDOs. Index funds on the other hand own the shares in companies that publicly trade where the market markers must provide liquidity hence a single trade at +/- 10% will not only move the quote but would trigger other buyers and sellers to decide to want to play.
doubleunplussed 7y ago
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.
- rdm70 7y ago
  The thing is, price moves are not symmetric up and down. Down tends to be much more violent.

FabHK 7y ago

> 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".)

OJFord 7y ago
> 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 His argument there AIUI was that the daily volume is not in proportion.
- FabHK 7y ago
  Fair enough, so going back to a liquidity mismatch. Will be interesting to watch the next market crash.

omgwtfbyobbq 7y ago

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/Annotation-2019-09-04-220027.jpg https://awealthofcommonsense.com/wp-content/uploads/2019/09/...

mcguire 7y ago
I think the point you want to make is that we've never had a market correction with the number of investors at current levels is accurate.

intuitionist 7y ago

There are also a lot more liquidity providers than there were in the past, no? I know there are concerns that the high-frequency traders will turn off the computers in a crash, but if the index funds have to sell their small holdings at a deep discount, that’s an opportunity for someone to step in and buy them on the cheap. I guess there are more legitimate concerns for funds that hold bonds or real estate or other less-liquid assets. But the solution to that is just, don’t put yourself in a position where you have to liquidate those funds in a crunch.

rocqua 7y ago
The high frequency traders I know of are market makers. They want to make money by buying and immediately selling stock. Earning a spread, but never having an actual position. For them, the prospect of holding a stock that is undervalued by 10% for a few days is not good. Other forms of algorithmic trading might still step in though.

thanatropism 7y ago

The title is terrible. The fundamental problem he seems to be pointing at is that notional replicating portfolios can work like an engineering marvel in good times and become inoperable in bad (liquidity) times. There were many elements to the CDO crisis -- including bad faith by the rating agencies and a prolonged asset-price mania much beyond this stock-market rally. The simpler metaphor is the emission of vanilla stock options. In principle, a bank is only able to offer options because he has the ability to replicate it and neutralize his risk. But if market conditions diverge from the asset replication model, then boom you get LTCM.

notyourday 7y ago
> The fundamental problem he seems to be pointing at is that notional replicating portfolios can work like an engineering marvel in good times and become inoperable in bad (liquidity) times. He is confused. That was the problem with the synthetic OTC instruments that he used which nearly tripped his winning position because no one wanted to actually trade with them. And even that was largely the case because he was buying not even CDOs but synthetic instruments that were derivatives of the CDOs. Index funds on the other hand own the shares in companies that publicly trade where the market markers must provide liquidity hence a single trade at +/- 10% will not only move the quote but would trigger other buyers and sellers to decide to want to play.

doubleunplussed 7y ago

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.

rdm70 7y ago
The thing is, price moves are not symmetric up and down. Down tends to be much more violent.