The Big Short’s Michael Burry Explains Why Index Funds Are Like Subprime CDOs

[ironchef]

Actually you as an investor can "create" a share of SPY by depositing a basket of stocks with them. Effectively institutions arb ETFs when demand for the ETF exceeds supply and create new shares in that manner (and can also do the opposite). So unlike a mutual fund, the ETF sponsor isn't out buying and selling underlying (for SPY at least). Detailed explanation in the prospectus.

Thank you sir.

A hypothetical question:

As the percentage of money investing in indices approaches 100%. What happen to the market? Would it be more or less volatile?

 

[Sig]

Thank you sir.

A hypothetical question:

As the percentage of money investing in indices approaches 100%. What happen to the market? Would it be more or less volatile?

That's kind of the unsupported assumption of the article author, that we can presume automatically that concentration=volatility. There are a couple issues with this. First, it would require that all money be pulled out of all stocks not in the S&P 500, for example, so every other company's stock would have to go to zero. If there is a problem with this trend toward indexing it's that we're moving in that direction, but it's unlikely we'll get there overnight. And on our way there (if we do effectively end up there), the economy will structurally change to consist of some form of private equity owning a significant percentage of the companies in the country, which from an economy perspective I would argue would significantly decrease volatility in the economy given the inertia of buying and selling PE owned companies.
As far as asking if concentration into fewer stocks increases volatility, I'm not sure that's an obvious conclusion. If the price earnings ratio stays similar to what it is today, then the only thing that's changed is that more invested wealth is in private equity funds than public stocks compared to today and total stock market float is reduced. Alternately price earnings ratios could go up significantly to absorb continued demand for this smaller universe of company stock. I suppose you could argue that either one would result in more volatility in stocks, either because of some yin and yang thing to balance the less volatile private equity side or because high price/earnings may lead to more speculative valuations and less fundamental valuations. I'd have to dig into the literature to see if there's any quantitative support for either of those hypotheses, or to see if there's some other hypothesis with some evidence based support. Anyone else have any ideas?