Are Index Tracking Funds a Safe Investment?
Not according to Michael Burry, the legendary investor
featured in the book and movie, The Big Short, who is predicting a 2008-style
crash.
featured in the book and movie, The Big Short, who is predicting a 2008-style
crash.
American Michael J. Burry is a physician, investor, and
hedge fund manager. He was the founder of the hedge fund Scion Capital, which
he ran from 2000 until 2008, before closing the firm to focus on his own
personal investments.
hedge fund manager. He was the founder of the hedge fund Scion Capital, which
he ran from 2000 until 2008, before closing the firm to focus on his own
personal investments.
Burry made a fortune betting against CDOs before the 2008
financial crisis and his estimate net worth is $250 million. He currently
manages over $100 million in his own fund.
financial crisis and his estimate net worth is $250 million. He currently
manages over $100 million in his own fund.
In an interview with Bloomberg, Burry said index fund
inflows (investment money) are distorting prices for stocks and bonds in much
the same way that CDO purchases did for subprime mortgages over a decade ago.
The flows will reverse at some point, he said, and “it will be ugly” when they
do.
inflows (investment money) are distorting prices for stocks and bonds in much
the same way that CDO purchases did for subprime mortgages over a decade ago.
The flows will reverse at some point, he said, and “it will be ugly” when they
do.
“Like most bubbles, the longer it goes on, the worse the
crash will be,” said Burry, who oversees about $340 million at Scion Asset
Management in Cupertino, California. One reason he likes small-cap value
stocks: they tend to be under-represented in passive funds.
crash will be,” said Burry, who oversees about $340 million at Scion Asset
Management in Cupertino, California. One reason he likes small-cap value
stocks: they tend to be under-represented in passive funds.
Here’s what else Burry had to say about indexing, liquidity,
Japan and more. Comments have been lightly edited and condensed.
Japan and more. Comments have been lightly edited and condensed.
“Central banks and Basel III have more or less removed price
discovery from the credit markets, meaning risk does not have an accurate
pricing mechanism in interest rates anymore. And now passive investing has
removed price discovery from the equity markets. The simple theses and the
models that get people into sectors, factors, indexes, or ETFs and mutual funds
mimicking those strategies -- these do not require the security-level analysis
that is required for true price discovery.
discovery from the credit markets, meaning risk does not have an accurate
pricing mechanism in interest rates anymore. And now passive investing has
removed price discovery from the equity markets. The simple theses and the
models that get people into sectors, factors, indexes, or ETFs and mutual funds
mimicking those strategies -- these do not require the security-level analysis
that is required for true price discovery.
“This is very much like the bubble in synthetic asset-backed
CDOs before the Great Financial Crisis in that price-setting in that market was
not done by fundamental security-level analysis, but by massive capital flows
based on Nobel-approved models of risk that proved to be untrue.”
CDOs before the Great Financial Crisis in that price-setting in that market was
not done by fundamental security-level analysis, but by massive capital flows
based on Nobel-approved models of risk that proved to be untrue.”
“The dirty secret of passive index funds -- whether
open-end, closed-end, or ETF -- is the distribution of daily dollar value
traded among the securities within the indexes they mimic.
open-end, closed-end, or ETF -- is the distribution of daily dollar value
traded among the securities within the indexes they mimic.
“In the Russell 2000 Index, for instance, the vast majority
of stocks are lower volume, lower value-traded stocks. Today I counted 1,049
stocks that traded less than $5 million in value during the day. That is over
half, and almost half of those -- 456 stocks -- traded less than $1 million
during the day. Yet through indexation and passive investing, hundreds of billions
are linked to stocks like this. The S&P 500 is no different -- the index
contains the world’s largest stocks, but still, 266 stocks -- over half --
traded under $150 million today. That sounds like a lot, but trillions of
dollars in assets globally are indexed to these stocks. The theater keeps
getting more crowded, but the exit door is the same as it always was. All this
gets worse as you get into even less liquid equity and bond markets globally.”
of stocks are lower volume, lower value-traded stocks. Today I counted 1,049
stocks that traded less than $5 million in value during the day. That is over
half, and almost half of those -- 456 stocks -- traded less than $1 million
during the day. Yet through indexation and passive investing, hundreds of billions
are linked to stocks like this. The S&P 500 is no different -- the index
contains the world’s largest stocks, but still, 266 stocks -- over half --
traded under $150 million today. That sounds like a lot, but trillions of
dollars in assets globally are indexed to these stocks. The theater keeps
getting more crowded, but the exit door is the same as it always was. All this
gets worse as you get into even less liquid equity and bond markets globally.”
“This structured asset play is the same story again and
again -- so easy to sell, such a self-fulfilling prophecy as the technical
machinery kicks in. All those money managers market lower fees for indexed,
passive products, but they are not fools -- they make up for it in scale.”
again -- so easy to sell, such a self-fulfilling prophecy as the technical
machinery kicks in. All those money managers market lower fees for indexed,
passive products, but they are not fools -- they make up for it in scale.”
“Potentially making it worse will be the impossibility of
unwinding the derivatives and naked buy/sell strategies used to help so many of
these funds pseudo-match flows and prices each and every day. This fundamental
concept is the same one that resulted in the market meltdowns in 2008. However,
I just don’t know what the timeline will be. Like most bubbles, the longer it
goes on, the worse the crash will be.”
unwinding the derivatives and naked buy/sell strategies used to help so many of
these funds pseudo-match flows and prices each and every day. This fundamental
concept is the same one that resulted in the market meltdowns in 2008. However,
I just don’t know what the timeline will be. Like most bubbles, the longer it
goes on, the worse the crash will be.”
“Ironically, the Japanese central bank owning so much of the
largest ETFs in Japan means that during a global panic that revokes existing
dogma, the largest stocks in those indexes might be relatively protected versus
the U.S., Europe and other parts of Asia that do not have any similar
stabilizing force inside their ETFs and passively managed funds.”
largest ETFs in Japan means that during a global panic that revokes existing
dogma, the largest stocks in those indexes might be relatively protected versus
the U.S., Europe and other parts of Asia that do not have any similar
stabilizing force inside their ETFs and passively managed funds.”
“It is not hard in Japan to find simple extreme
undervaluation -- low earnings multiple, or low free cash flow multiple. In
many cases, the company might have significant cash or stock holdings that make
up a lot of the stock price.”
undervaluation -- low earnings multiple, or low free cash flow multiple. In
many cases, the company might have significant cash or stock holdings that make
up a lot of the stock price.”
“There is a lot of value in the small-cap space within
technology and technology components. I’m a big believer in the continued
growth of remote and virtual technologies. The global retracement in
semiconductor, display, and related industries has hurt the shares of related
smaller Japanese companies tremendously. I expect companies like Tazmo and Nippon
Pillar Packing, another holding of mine, to rebound with a high beta to the
sector as the inventory of tech components is finished off and growth resumes.”
technology and technology components. I’m a big believer in the continued
growth of remote and virtual technologies. The global retracement in
semiconductor, display, and related industries has hurt the shares of related
smaller Japanese companies tremendously. I expect companies like Tazmo and Nippon
Pillar Packing, another holding of mine, to rebound with a high beta to the
sector as the inventory of tech components is finished off and growth resumes.”
“The government would surely like to see these companies
mobilize their zombie cash and other caches of trapped capital. About half of
all Japanese companies under $1 billion in market cap trade at less than
tangible book value, and the median enterprise value to sales ratio for these
companies is less than 50%. There is tremendous opportunity here for re-rating
if companies would take governance more seriously.”
mobilize their zombie cash and other caches of trapped capital. About half of
all Japanese companies under $1 billion in market cap trade at less than
tangible book value, and the median enterprise value to sales ratio for these
companies is less than 50%. There is tremendous opportunity here for re-rating
if companies would take governance more seriously.”
“Far too many companies are sitting on massive piles of cash
and shareholdings. And these holdings are higher, relative to market cap, than
any other market on Earth.”
and shareholdings. And these holdings are higher, relative to market cap, than
any other market on Earth.”
“I would rather not be active, and in fact, I am only
getting active again in response to the widespread deep value that has arisen
with the sell-off in Asian equities the last couple of years. My intention is
always to improve the share rating by helping management see the benefits of
improved capital allocation. I am not attempting to influence the operations of
the business.”
getting active again in response to the widespread deep value that has arisen
with the sell-off in Asian equities the last couple of years. My intention is
always to improve the share rating by helping management see the benefits of
improved capital allocation. I am not attempting to influence the operations of
the business.”
“I sold out of those investments a few years back. There is
a lot of demand for those assets these days. I am 100% focused on
stock-picking.” Source: Bloomberg.
a lot of demand for those assets these days. I am 100% focused on
stock-picking.” Source: Bloomberg.
In short, pardon the pun, Burry is saying that index or
tracking funds are not safe and the amount of money flowing into them is
creating a massive bubble, which will ultimately burst causing a recession.
tracking funds are not safe and the amount of money flowing into them is
creating a massive bubble, which will ultimately burst causing a recession.
But what about managed mutual funds and unit trusts? Surely,
if the index funds crash, surely they will follow since they always tell their
investors to “stay invested” or “ride out the storm” and people get burned.
if the index funds crash, surely they will follow since they always tell their
investors to “stay invested” or “ride out the storm” and people get burned.
I am not your financial adviser, so take advice on your
investments and pensions funds.
investments and pensions funds.
Word of the Day
Index and Tracker Funds
An index or tracker fund is an index fund that
tracks a broad market index or a segment thereof. Tracker funds are
also known as index funds. These funds seek to replicate the
holdings and performance of a designated index. Tracker funds are
designed to offer investors exposure to an entire index at a low
cost. Source: Investopedia.
tracks a broad market index or a segment thereof. Tracker funds are
also known as index funds. These funds seek to replicate the
holdings and performance of a designated index. Tracker funds are
designed to offer investors exposure to an entire index at a low
cost. Source: Investopedia.
There are more examples and practical steps to getting rich
and being happy in my book, Yes, money can
buy happiness, I cover the 3 R’s of Money Management, the Money B.E.L.I.E.F
System and much more. Check it out on Amazon http://bit.ly/2MoneyBook.
and being happy in my book, Yes, money can
buy happiness, I cover the 3 R’s of Money Management, the Money B.E.L.I.E.F
System and much more. Check it out on Amazon http://bit.ly/2MoneyBook.
See more at www.moneytipsdaily.com:
No comments:
Post a Comment