It sounds like everyone is shooting down the contrarian view here before it’s had chance to breathe. Shouldn’t we be a little less presumptuous and examine the debate with a bit more diligence? Surely this community, given the comparatively non-traditional life-choices we’re making, is one that should be more open to diverse opinion and alternative insights, not least because it may potentially aid us.
Don’t get me wrong, I too am a massive advocate of passive index investing. I currently have 95%+ of my money invested that way and I have previously worked for a well-known UK version of Betterment, so I totally get the industry, the investment style and the historical landscape to active / passive.
I agree with the MMM blog post, of course, in that the financial media is full of irrelevant speculative guff, designed to baffle the punter and line the pockets of those in the industry. The old adage rings true - if these so-called experts really knew what was going to happen then they wouldn’t be in mid-salary jobs writing about it, they’d be retired on a beach somewhere enjoying the profits.
But I also agree that it’s very different when someone like Burry speaks up, given his rare credentials. (He seldom gives interviews so why he’s chosen to come out about this right now I’m not sure. I see he’s been pushing certain US and Japanese small cap stocks that he’s recently heavily invested in so maybe it’s linked to that??)
Anyway, I think it’s foolish to tear up Burry’s assessment without full investigation and on reflection I believe he makes a lot of very salient points…
1. I totally agree with Burry that there’s a fake environment being created as a result of the very fast rise in passive investing. The switch from active to passive has been dramatic in the last few years! As a result, value and price discovery - essential components of a well-functioning open financial market - are rapidly being disabled. That’s not good. We need true pricing. I believe the more money people throw into the likes of Betterment model portfolios - sold on the undeniable principles of diversification, low fees, rebalancing, auto-reinvest of dividends, etc - then more capital flows to the mainstream funds and ETFs used in constructing said portfolios, and the further the share prices within them get propped up and inflated (on mass) on the FTSE, the S&P and the rest. Active trading is split - buy / sell. The vast majority of passive trading is buying, not selling. So, with the latter, all the buying is simply pumping up the prices without any care for valuation.
2. I can therefore see why Burry has shifted his investor focus to niche industries and small caps, since ETFs and other passive funds are often more focused on mid and large cap indexes, meaning the smalls are retaining more of their genuine price and so that’s where value can be discovered.
3. MMM says “A small exit door only matters if everyone is running for the exits at once. And even then, as index fund investors (as opposed to active stock traders), we don’t do that”… With the utmost respect, I don’t think passive investors as a whole have the knowledge and acumen to sit tight if things get rocky. They won’t. They’ll run for the hills. Passive investors are now your everyman and everywoman on the street - not just the likes of us. Institutional orgs and pension funds will also get spooked and go running back to their familiar foes at the first glint of mayhem. We’ve recently seen chaos in the UK with the highly popular Woodford Fund where a trickle of withdrawals suddenly became an avalanche. Humans aren’t good at riding out the rollercoaster.
4. The tipping point MAY not be far off. We simply don’t know. The gap is closing fast between active and passive. And certain activity masks how close things really are. For example - “active trading still outweighs index fund trades by 22-to-1” - yes, of course it does, because by nature there is a high volume of trading in the active style and a low volume of trading in the passive style. But in terms of total value held on the major western indexes, it’s now pretty much a 50/50 split. What even IS the 'tipping point'? We’ve never experienced this before! Who’s to say the prices aren’t hugely inflated already and a bubble-burst is round the corner? We don’t KNOW for certain.
5. Re the MMM blog post on this, to look only at the two ends of the spectrum - the 100% active scenario and the 100% passive scenario - as being workable is a mistake. Yes, both scenarios MAY function fine, but that doesn’t mean every mix of the two along the spectrum would also work ok and not present problems.
6. To say, ‘well, if people withdraw they’ll have to re-invest it again somewhere’ is fair enough to a point, but that doesn’t mean it’ll go back into traditional markets, large cap stocks, or even stocks at all. We MAY end up realising in hindsight that current market valuations on big index firms are actually 30%+ over-priced right now and that they settle back down to that much lower true valuation after a bubble-burst. That would hurt us all, a lot.
Personally, I’m still cogitating and researching. We all have to make our own decision on this stuff. But I would implore everyone to NOT be over-complacent and make sure your decision is a fully-informed one. Don’t hold on to the comfort blanket of passive investing (that you’ve found to be so successful to date) for the sake of it. Nothing lasts forever. Arrogance is easy.
Of course, I don’t know either. But for me, gut feel right now says:
1) A more harmonious combination of active and passive investing may ultimately become the new norm - eg, ‘active’ analysts deciding which stocks go into an ETF, based on risk profile and other factors, not just whether it’s a basket of FTSE 100s or S&P 500s or whatever, which is actually incredibly basic and pretty dumb when you think about it. (Why are investment choices still so dominated by indexes run on size of company, geography and industry??)
2) A new level of diversification may be needed to combat the risks of a potential passive bubble - eg, I may look to take XX% of my investments out of passive portfolios and spread it across a mix of other investments - small niche caps a la Burry, commodities, the credit markets, the currency markets, etc. Ultimately, I don’t want to have to do this, I want someone doing it for me, but at the moment all passive / index portfolio investment firms seem to have a fairly similar model and are dead set on mid/large cap globalised equity-based funds. YAWN!!!
