If the underlying stock is not liquid, and the AP can’t convert shares, the ETF might trade at a discount. I don’t think such discount would stay long term though (if the stock is not liquid, and people want to sell it, its market value should drop until it becomes liquid again).
It might matter for people doing active trading with ETFs though, but for long term investor not so much.
According to a study published last week by Morningstar, passive US equity funds have finally surpassed active US equity funds in assets under management.
By the end of August, passive US funds had total net assets of $4.27 trillion, compared with $4.25 trillion in active US equity funds, according to data provided by Morningstar.
Also, they note a pretty interesting fact:
Morningstar’s study also found that in the 10-year period to June 28, 2019, cheaper funds had a 33% success rate compared to pricier funds’ 14% success rate.
Interesting take on the subject here: https://www.epsilontheory.com/ive-got-a-secret/
The importance of the narrative is paramount, as explained quite thoroughly by Yuval Harari in Sapiens for instance.
I’m still very much of a noob, just started investing this year, but I’m getting less and less affected by these headline stories so I guess I’m on the right track.
History will prove us right or wrong anyway, so I tend not to worry too much about it.
Blockquote When investors want to sell their ETF holdings, they can do so by one of two methods. The first is to sell the shares on the open market. This is generally the option chosen by most individual investors. The second option is to gather enough shares of the ETF to form a creation unit, and then exchange the creation unit for the underlying securities. This option is generally only available to institutional investors due to a large number of shares required to form a creation unit.
So basically this pressure on illiquid stocks by sell off of ETFs would have to come from institutional investors. However on a normal mutual fund I understand when anyone sells it is traded directly with the fund company.
I don’t say Burry is right again (has he shorted index funds this time?). But he was in the past when everyone else seemed to be in denial.
Ultimately the underlying assets are the biggest companies in the market, not high default risk mortgages…
I hope this only leads to a bump in the road (if he is proved right) and the market recovers in a couple of years tops.
Personally your feedback really helped me understand better what I am buying so thanks a lot!
Passive investing tends to distort the prices of individual stocks, because we buy everything in a fixed ratio without considering the value of each company .
The “exit door” is small – there is a lot of money invested in fairly small companies whose shares are not frequently traded. So if we all tried to sell at once, we’d have way too many sellers and very few buyers. This would cause a massive price crash in the stock prices of these small companies.
There are some complex bits under the hood of index funds – things like options and derivatives that can break under stress and cause money losses or more volatility.
(…)
But instead of picking a fight, let’s just address these points one by one:
Yeah, but active traders have been making this argument against passive investing forever. The theory is correct, but in practice it would only be a problem if too many of us became passive and there were no active traders left. Thus the real question is: Are we close to this tipping point? And the easy answer is “Not even close”. Index funds own about 18 percent of global shares, and 45 percent here in the US. And active trading still outweighs index fund trades by 22-to-1.
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. And even in the event of liquidity problems in a big sell-off, the only downside would be some bigger temporary price swings. We don’t care about those either.
To better answer this question, I interviewed some of the people deep inside the machine – Betterment’s investing team and their director Dan Egan. A summary of their thoughts – This is actually more of a problem for “Synthetic” or leveraged index funds, not the true funds we invest in. For the most part, in the index funds you and I use, our money simply purchases real shares of businesses.
I don’t really get this “passive investors don’t sell”…
If you retire early you do have to sell at regular intervals to be able to pay for your living expenses.
Also, sequence of return risk matters a lot, buying large quantities of securities before draw-downs is very unfortunate…the more it goes down the longer you have to wait before making it back to zero.
To be sure, I’m not talking about trying to time the market, I’m talking about (1) having to sell and (2) the risk of when you come onboard
I would describe it that the active investors goal is to be smarter than the market. They know that crashes/dips are normal but want to make profit of it (sell high/buy low). And the passive investor understand that crashes/dips are part of the long-term game and even sees them as a chance to build and invest more.
Normally FIRE date is not set in stone and people are flexible with it. If you’re facing a crash just after you’re FIRE, then too bad - you need to work one more year to sustain your portfolio. How is that a problem?
Well, I still haven’t understood the mechanics of how ETF holders are in danger. If there is a market crash, you’re screwed regardless if you hold your stock in an ETF or directly. Then you just withdraw as much as you need, provided that you’re retired, and wait for better times.
What are they actually talking about? That our ETF provider would go under somehow, or what? Because if the only worry is that the ETF might become illiquid for a couple of hours (small exit door) then I don’t see how should that be a problem for anyone else than day traders.
I agree thats not a problem. But we’re perhaps deviating a bit from the topic. The main concern about (eventual) index investing dominance in my view is that it could create opportunities for active strategies that ultimately would reduce your gains. But as that would make active more attractive it would reduce the index dominance risk again. Just a question if thats not something you could profit from too.
No worries, I don’t get most of them either. You just posted a link which has been posted a few posts above (repost), so you probably started reading the thread from the middle.
I’m pretty sure that the passive/active ratio will reach an equilibrium at some point. For years the active funds had it easy because they could have been trailing the market and still pocket the 2% fee. Now they will have to do a better job and possibly lower their fees. The funny thing is, active traders can only get an edge over indexers by beating other active traders, as passive stock holders do not participate
Well let´s say for the sake of an argument there is an ETF with bonds. In case of a crisis, some investors will try to get out and sell that ETF, so that the issuer has to rebalance that portfolio. In case of bonds (which are usually not that liquid) those prices will fall, because nobody want to buy in that negative phase, but the ETF issuer (probably a bot) must sell. So that this will turn rapidly south and the prices will even drop more.
So maybe if we see that situation but in a more extreme form with ETF shares. Maybe with a market share in the future of >30% or more, this also might become a potential risk. At the end they are managed by bots, who are programmed and react all in a similar way with similar trigger points.
yeah, but it gets its own shares in exchange, which it destroys
I fail to understand how does an ETF make it worse. I guess this could only become a problem if the ETF was cheating and creating its units without the underlying shares to cover for it. I wonder what checks are there to make sure this doesn’t happen.
So if only passive investors panic and sell their ETF shares, at first just the ETF shares’ price falls. This gives the APs a source of cheap ETF shares to exchange for the underlying set of “real” shares (that still have the original high price). Then they can do whatever they wan’t with them. If all the APs automatically sell the shares they get from the ETF, then it would cause a drop in the real market… But they don’t have to sell. There’s still a second layer of protection there, that could slow down the panic.
sequence risk sometimes means waaaaay more than 1 year to get back to zero…Big ERN’s blog has a bunch of analysis about this.
I agree being pessimistic just means you never participate, but being super optimistic and thinking that if something goes wrong everything would be fine one year later is how many people got fleeced out of their retirement savings last time around.
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