...no. A piece at a time, from Burry: Nobody is losing money where they should be because there's been so much free government cash flooding the markets. And ETFs have made it so that the price of an equity has nothing to do with the value of an equity. The things people are buying hide the underlying aspects of the stuff that makes up the things people are buying. CDOs were make-believe products driven by make-believe models with very real money pumping into them and as soon as the model and the reality diverged, I was destined for a Michael Lewis book. That which ACTUALLY makes up an ETF has fuckall to do with what the funds PROFESS to make up an ETF. The amount of money indexing is not at all related to the amount of money represented in the stocks that make up the index which means a tiny move in the real stock market becomes a huge move in the index funds. The guys who are selling these things are collecting nickels in front of steamrollers because THEY aren't the ones doing the running. YOU are the one who is going to get run over. The problem in 2008 wasn't mortgages defaulting, it was the annihilation of the derivatives whose value was determined by those mortgages. The problem with ETFs won't be any hypothetical drop in the underlying value of the equities that make up the ETFs - the problem will be the mechanism by which those losses are translated into the ETFs because there's leverage and transformation between the values of the two. Now, here's Ben Carlson: Herp derp I don't understand Burry well enough to object to what he's saying here's a bunch of random platitudes I mean, Carlson is basically writing a rebuttal of the argument that index funds are bad because nobody is managing your money. Nowhere was that argument made by Burry. Burry's argument was that the mechanisms by which ETFs are constructed are perverse and weird and subject to different forces than the supply and demand of the underlying equities and Carlson legit didn't understand that.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.
“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.”
“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.
“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.
“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.”
“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.
Ah, got it. I've been keeping an ear to the liquidity thing, but this situation makes some more sense to me. So there's a bunch of shitty low liquidity stocks making up ETFs that are going to get vaporized once the market moves in such a manner that the index funds require re-balancing and no one is looking to buy them. The same mindless mechanism that gave them life will kill them off.The problem in 2008 wasn't mortgages defaulting, it was the annihilation of the derivatives whose value was determined by those mortgages. The problem with ETFs won't be any hypothetical drop in the underlying value of the equities that make up the ETFs - the problem will be the mechanism by which those losses are translated into the ETFs because there's leverage and transformation between the values of the two.
Humor me a minute because your confusion is typical of everyone who looks at this and it's important to try and dispel it because it fucking matters. Did you... get anything from that? No? Congratulations. You weren't supposed to. That's a screenwriter's trick. It's called "The Pope in the Pool." The phrase was coined by Blake Snyder, a nice guy who was a terrible screenwriter who took the limited success from Stop Or My Mom Will Shoot to launch a career as a screenwriting guru. "The Pope in the Pool" comes from a scene in the unmade script The Plot to Kill the Pope wherein a bunch of necessary (but boring) exposition is delivered by someone yammering while the screen is filled with the pope, wandering through a swimming pool in a bathing suit. The idea is that by giving the audience a distracting image, you can bathe them in bullshit that's boring that you, as the storyteller, don't want them to know but you, as the storyteller, need them to know or else nothing will make sense. It's worth noting that Blake Snyder's magnum opus is a book called Save the Cat! - on the example that the first thing you should do is have your protagonist do something endearing like... save a cat. That makes them likeable, you see. It's such base-level bullshit that you get writers' in-jokes like this: Yeah. First scene in House of Cards is Frank Underwood killing a dog. The anti-Save the Cat!. How droll. It's worth noting that Save the Cat! is third-gen screenwriting advice. The content in it is basically a paint-by-numbers dumbing-down of William Goldman's Adventures in the Screen Trade. By way of comparison, Goldman had an Oscar when he wrote it. The "save the cat" advice in Adventures in the Screen Trade is not to have your hero save an animal, it's to not let your hero act in a callous and insensitive way even when it's totally motivated by reality and plot. The example used is Goldman's own Great Waldo Pepper: SPOILERS: she plummets to her death and Robert Redford doesn't save her. It's worth noting that Adventures in the Screen Trade is famous for the tagline "nobody knows anything" because it was, in no small part, a rebuttal of the first-generation screenwriting book Screenplay which is basically a narrative version of Cole & Haag which was basically a formula for how to do whatever the fuck you want so long as the page count and formatting is right. So. From "here's what a screenplay should look like" to "Here's Margot Robbie instead of understanding", institutionalized. This matters because we learn not from statistics or math but from narratives. There's a plot device in screenwriting called the MacGuffin. What's a MacGuffin? Nobody cares. Somebody wants it, someone else has it, what it actually does doesn't matter. And within The Big Short, the actual mechanism by which the economy crashed is a MacGuffin. It's a thing that doesn't fucking matter. Michael Lewis is a great writer. But what he writes is HOW, not WHY. And as The Big Short has basically become the narrative of the 2008 financial crisis, all we care about is how it came about, not why it came about. This is unfortunate in that there were other narratives. The Big Short's principle narrative was that some people were smart, more people were dumb, and the smart people got rich while the dumb people lost everything. Prior to it, however, the narrative was about quants and exotic financial instruments and the preposterous complicated risks that were layered and interwoven in order to sell to others. Here's Brad Pitt in The Big Short: In the movie he basically plays this same character from True Romance: In real life, however, the person he's playing was more like this Brad Pitt: What REALLY happened with CDOs is that everyone selling them knew they were bullshit but nobody buying them was sophisticated enough to know it. Michael Burry (and others) were the ones who had the money to bet against an entire segment (Burry famously paying Goldman Sachs to create a special instrument just for him that would allow him to bet against the market - it's better to say that Michael Burry won a wager than that he invested. Because fundamentally, the narrative on CDOs was that they were investments that produced outsized yields through acceptable risk. The reality of CDOs was they were a way to make money by buying risky loans, with the riskiest loans paying the most money. If that's a junk bond, everyone understands it - filter it through enough statistical and mathematical laundering and it's a black box. Prior to The Big Short, the financial crash was about clever banks that managed to hide nasty bullshit in stuff they sold as if it were roses and they should all go to jail. After The Big Short, the financial crash was all about clever venture capitalists who saw a risk nobody else foresaw. Narratives matter. And the narrative on ETFs is that they allow you to buy a market segment without experiencing any risk. The reality of ETFs is they're a derivative that nobody's looking at and the way they trade is not the way anything else trades. The incentives in the construction of an ETF are wholly removed from the incentives of buying an ETF. The incentives in the management of an ETF are wholly removed from the incentives of owning an ETF. And this is why there are eleventy-seven arguments against Burry - because everyone is parroting the narrative they've all learned about ETFS, which is they're great because they aren't actively managed and there's no risk after all you're just buying a basket of stocks. But you're not. You're buying a magic number that you're giving an arbatrageur the opportunity to scalp in exchange for meeting an arbitrary goal. The goal of a mutual fund is to MAKE MONEY. If you buy a mutual fund, you are 100% aligned with the fund managers. The goal of an ETF is to HIT AN ARBITRARY NUMBER AT ANY COST. If you buy an ETF, your goals and the ETF creation units holders' goals have no correlation whatsoever. My favorite platitude of investing is "bear markets return capital to its rightful owners." The people paying attention to what's going on, as opposed to what they're being told have an advantage. CDOs were considered low risk because a national decline in housing prices was calculated to be a "six sigma event." In other words, according to the math used in their creation, the sun was more likely to go nova than for there to be a national decline in housing prices. Of course, when you create a powerful incentive to generate risky mortgages you fundamentally alter the makeup of the housing market. This is the sort of externality that none of the CDO originators included in their model because if they had, they couldn't have sold them. And yeah - if there were a few million dollars worth of CDOs they would have been a cautionary tale. But there were two trillion dollars' worth. And there are three trillion dollars worth of ETFs. It's worth noting that Michael Burry was diagnosed with Aspberger's shortly after he made all his money. It made sense to him - he'd never liked people, he'd never understood them, and he had a challenge communicating with everyone. This probably gives him an advantage in cutting through bullshit narratives - the collective wisdom is much less available to him simply because he doesn't plug into the zeitgeist the same way. The zeitgeist is that ETFs and stocks are interchangeable (with ETFs being objectively better). The reality is that ETFs are pretending to be stocks and as soon as the situation is stressed, there's no reason to believe they'll behave like stocks. In fact, there's every reason to believe they'll behave like CDOs. They'll behave like short squeezes. They'll behave like a bunch of disparate equities that have no reason to be interlinked that are tragically interlinked nonetheless. And that could get interesting. Did I explain that adequately?
Cornwall seeks highly asymmetric investments, in which the upside potential significantly exceeds the downside risk, across a broad spectrum of strategies ranging from trades that seek to benefit from market inefficiencies to thematic fundamental trades. The firm has produced an average annual compounded net return of 40 percent (52 percent gross). Cornwall Capital was one of a few investors who saw and shorted the subprime mortgage crisis market prior to the 2007 collapse; according to Michael Lewis, they were perhaps one out of 20 in the world who did so.[5][9] This particular trade generated 80 times the initial premium (investment).[1] The founders of Cornwall Capital started a hedge fund in their garage with $110,000 and built it into $120 million when the market crashed.
I believe so. My understanding is that in ETF rebalancing equities that are part of the basket are treated like nothing but paper, mindlessly bought, mindlessly sold. Unlike a mutual fund, there is no one worried about the value of the ETF. And when lots of ETFs need to do the same thing with the same stock, it could be really good or really bad for the stock. What I meant, is that the same mindless ETF inclusion that gave life to equities will remove it.The same mindless mechanism that gave them life will kill them off.
They're matching a number. That number is unrelated to their profit. Where they profit is in, for example, buying 1000 shares of XYZ for $4.13 instead of $4.14. The 1000 shares are gonna be bought by the end of the day. If they can buy 2000 shares for $4.13 and sell 1000 of them for $4.15, they will have made $10 in keeping XYZ at 1000 shares. The value of the ETF is not their responsibility. The ETF matching the terms of the prospectus is their responsibility. In order to do that, they exercise whatever trades, purchases and sales they set forth in the prospectus which, from our LACK example means repos, junk bonds, whatever. And again - if LACK is worth $4 on Thursday and $5 on Friday, they've got to come up with a way to grow their fund by 25% by Friday. However they want to. By whatever means necessary. Precisely that. "I need to buy a thousand shares of GOOG because that's what balances the numbers and if the price is up 29%... uhhh..." "I need to sell a thousand shares of GOOG because that's what balances the numbers and if the price is down 50% we're selling because that's what the numbers want." The problem is that "remove" is likely an extremely gentle euphemism for certain possible scenarios.My understanding is that in ETF rebalancing equities that are part of the basket are treated like nothing but paper, mindlessly bought, mindlessly sold.
Unlike a mutual fund, there is no one worried about the value of the ETF.
And when lots of ETFs need to do the same thing with the same stock, it could be really good or really bad for the stock.
What I meant, is that the same mindless ETF inclusion that gave life to equities will remove it.
