Viw Magazine

Men's Weekly

.

  • Written by Richard Holden, Professor of Economics, UNSW
Christian Bale plays quirky hedge fund Michael Burry in The Big Short (2015). www.imdb.com

If you’ve seen the movie The Big Short you will remember Christian Bale’s quirky character Michael Burry – the manager of the Scion Capital hedge fund who realises the US mortgage-backed security market is a massive bubble. He goes on to make a fortune by betting on its crash.

Given Burry’s track record, he’s hard to ignore. Last week in an extended (email) interview with Bloomberg News he claimed to have identified the latest bubble: passive investing.

Whereas active investment is about choosing particular stocks based on their potential to outperform the market, passive investing is all matching the market. It’s generally done through index funds, which spread their investments across the stock market.

An index fund might, for example, be based on the S&P500 index, making weighted investments in the top 500 listed companies in the US. An Australian fund might be based on investing in the Australian Securities Exchange’s ASX 200 index. If a given company represents 3% of the index, a passive investor will put 3% of their money into that stock.


Read more: What’s an index fund?


Passive investing has become hugely popular for a couple of reasons. One is that passive funds generally charge very low fees, like 0.2% a year. Sometimes even lower. Another is that that passive funds typically provide higher returns than all but the best active fund managers.

Lower cost, higher returns. What’s not to like?

Passive endorsements

Perhaps that’s why legendary investor Warren Buffett’s general investing advice is to buy an S&P 500 low-cost index fund: “I think it’s the thing that makes the most sense practically all of the time.”

Eugene Fama, a Nobel Prize winner in economics and the father of the “efficient markets hypothesis”, gives the same advice: “The default option in a government-mandated program should be low-fee passive funds.”

Fellow Nobel Laureate Richard Thaler (and colleague of Fama at the University of Chicago) concurs. Interestingly, Thaler’s Nobel award was for documenting how people make irrational decisions, while Fama’s was for the opposite. Even with such different perspectives, they agree passive investing is the way to go.


Read more: In defence of active fund managers


Why then, does Burry think he’s spotted another bubble?

For one thing, passive investment has become a huge part of the market – perhaps partly due to the recommendations of the likes of Buffett, Fama and Thaler. According to Bank of America Merrill Lynch, passive investing now represents 45% of the overall stock market, up from 25% a decade ago.

Burry thinks all that money automatically flowing into stock indices means nobody is doing fundamental analysis of what stocks are good. As he put it in his Bloomberg interview:

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.

To Burry, not looking at individual stocks is like not looking at the individual loans that investment banks packaged up into the mortgaged-backed securities. Without that stock-by-stock analysis, he thinks prices aren’t reflecting their “true” value by being bought and sold on their own merits. Economists call this form of price determination through analysis and then buying and selling “price discovery”.

According to Burry:

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 [exchange-traded funds] and mutual funds mimicking those strategies – these do not require the security-level analysis that is required for true price discovery.

Small discoveries go a long way

If passive funds were 100% of the market, Burry’s argument would have real force. In that case nobody would be looking at fundamentals, and there would be no reason to believe a large market capitalisation stock deserved to be so. There would be all herding and no price discovery.

But the crucial point is that even a small amount of price discovery can go a long way in getting market prices to reflect underlying value.

Burry ought to know this. It was in no small part due to his own analysis and price discovery that led to the correction (crash) in prices of supremely overvalued mortgage-backed-securities in 2008.

Moreover, those markets were extremely opaque. Burry’s strategy to “short” them required using credit default swaps (a type of derivative) in non-exchange or “over the counter” markets (basically just contracts with investment banks). This allowed mispricing to persist for even longer than it should have.

Markets for equity securities, on the other hand, are incredibly large and incredibly liquid. Anybody who spots mispricing can easily profit from that information through buying and selling stocks. That is what drives stock prices toward their “true” value.

Burry is right about there having been a huge increase in passive investing. But that’s a good thing. It’s helping individual investors get higher returns at lower cost. But at 45% of the market, there is no danger of passive investing creating a bubble.

Richard Holden does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.

Authors: Richard Holden, Professor of Economics, UNSW

Read more http://theconversation.com/vital-signs-all-this-overinflated-talk-about-an-index-fund-bubble-is-very-passive-aggressive-123441

VR Training in Australia – Conflict Resolution Training For Employees

In today’s rapidly evolving workplaces, Australian organisations are turning to immersive learning tools like VR to handle specialised n...

Financial Planning For Couples

Why Every Couple Should Talk About Money And A Will (Before It’s Too Late) When you’re in a new, exciting relationship, it’s easy t...

Navigating Relationships While Living with Depression

Living with depression can feel like carrying an invisible weight—one that not only affects how you experience the world but also how yo...

Choosing the Right Vinyl Flooring Suppliers for Your Home or Business

When it comes to selecting flooring options that combine durability, style, and affordability, vinyl flooring stands out as a top choice. ...

Why Food Manufacturing Cleaning Services Are Essential for Safety and Quality

The complexity of food production environments demands specialised cleaning approaches that go beyond regular janitorial work. This is whe...

The Importance of Choosing the Right Industrial Electrician Melbourne for Your Business

When it comes to powering large-scale operations and complex machinery, commercial electrical services are not enough. Industrial environm...

What to Expect During a Property Settlement After Separation

Separation is a challenging and emotional time, and one of the most complex aspects can be the division of property. However, understandin...

Designing the Ideal Healthcare Environment with a Professional Medical Centre Fitout

When it comes to healthcare spaces, functionality, hygiene, and patient comfort take top priority. An intelligently designed medical centr...

Stay Comfortable Year-Round with Ducted Cooling Melbourne

When the temperature starts to rise, having a reliable and efficient cooling system becomes a priority. With unpredictable weather and sud...

Best Practices for Content Ownership and Tagging Across Departments

Image by kaboompics on Freepik The bigger and more complex content ecosystems grow, the more valuable ownership and tagging become. In ent...

Understanding Public Liability Insurance Australia: What You Need to Know

Image by rawpixel.com on Freepik The necessity of public liability insurance in Australia is that it acts as a financial safeguard for busi...

How HID Proximity Cards Improve Workplace Security Without Slowing Down Access

In today’s workplaces, security is non-negotiable, but so is speed. Companies are under pressure to protect their people, property, and ...

Unlock Business Insights Faster with Power BI Tools

In this digital age where data drives the consumer landscape, businesses are shipping huge amounts of data every day. To remain competit...

Why Split System Installation Is a Smart Choice for Home Climate Control

Temperature control is essential for comfort, and when it comes to efficient, versatile cooling and heating, a split system is one of the ...

What You Need to Know About SMSF Setup in Australia

Setting up a self-managed super fund (SMSF) is becoming an increasingly popular choice for Australians who want more control over their re...

The Ultimate Guide to Door Replacement: Everything You Need to Know

Image by freepik Sure, swapping out a door is a fairly easy task, but it requires careful consideration of options for materials, designs...

Common Web Development Issues Perth Businesses Face (and How Agencies Fix Them)

Image by freepik Let's be honest, in the bustling heart of Perth's business scene, a website that's not up to scratch is like trying to he...

Life With Clear Aligners: 10 Small Changes That Make a Big Difference

Image by tonodiaz on Freepik Clear aligners have transformed orthodontics, offering a nearly invisible way to straighten teeth without the...

Choosing the Right Hair Loss Treatment for Your Needs

Millions of people experience hair loss globally, and it can be a major cause of emotional discomfort and self-consciousness. Hair loss ca...

Cardboard Display Boxes: An Effective Solution for Retail Presentation

In the competitive world of retail, how products are presented can be just as important as the products themselves. Cardboard display boxe...