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As others have noted, there's a lot here that isn't relevant to Burry's argument, but this seems like the key rebuttal to me: Active funds literally own the ma
by dkarl 7y ago
As others have noted, there's a lot here that isn't relevant to Burry's argument, but this seems like the key rebuttal to me:
Active funds literally own the market. When you buy an index fund of the total stock market, you are literally buying the stock market in proportion to the shares held by all active investors. If you sum up the collective holdings of active managers, what you basically get is a market-cap-weighted index. Index fund investors are simply buying what the active investors have laid out for them.
I don't have the knowledge to evaluate this statement, but to me, it undermines Burry's point that passive investing distorts prices.
And this bit that he quotes from someone else expands on the point:
The use of price signals by those who played no role in setting them may be capitalism’s most important feature. That most of us and most of our dollars don’t have to pick stocks, or to price air conditioners, is a great benefit and taking advantage of it makes us honest smart capitalists, not commissars.
As I understand it, Burry's argument is that index funds distort prices because capital is being allocated in an automated and uniform way, instead of being allocated according to the expertise of a diverse, success-weighted group of investors who are motivated to make intelligent and informed decisions. At some point the difference between the index-fund-driven prices and the "true" prices according to informed opinion will become obvious, and investors will attempt to flee index funds, popping the bubble. The rebuttal in this argument is that active investors are still controlling the market because index funds mirror their activity. We will never reach a state where people will rush to "escape" from the index funds to actively managed funds, because index funds will always approximate the aggregate opinion of the actively managed funds.
This accords with my naive idea of how index funds work, but I don't know if they actually do work that way, so I can't evaluate the soundness of either argument.
- christophilus 7y ago> Index fund investors are simply buying what the active investors have laid out for them. That works until it doesn't. If passive becomes big enough, the indices themselves will be the ones steering the ship. The active managers won't be significant enough to sway the indices. I heard this analogy on a podcast (I think it was Invest Like the Best): Indices are like a drunk person, and active managers are like the sober friend guiding the drunk home. But if the drunk becomes 10x the size of the sober friend, the friend is no longer strong enough to be a guide. If passive funds get big enough to dwarf active management, they eventually will be the ones steering the market, and active investors will be noise at that point. In that scenario, I'm not sure what happens, but it seems that indexing would become more like a Ponsi scheme.
- dkarl 7y agoAs I understand it, the index funds aren't drunk and aimless, forced in a certain direction as a side effect of the trades of active investors. They are intentionally and methodically following the active investors.
- yborg 7y agoOr the underlying companies that are traded. This "evil zombie index fund" trope seems to imply that index managers just continue to blindly buy the stocks in the index regardless of events, falsely inflating the value of companies. If a company is unable to generate cashflow from its underlying business, this will quickly become evident because it will be unable to pay its creditors and employees. It could take advantage of its "inflated value" by issuing shares to generate cash, but this would then obviously begin diluting the stock and cause the price to fall, the "zombie indexes" wouldn't simply continue to price it at a constant value. I.e. price discovery will happen, just perhaps not as quickly as an active analyst monitoring the stock would do it.