The rise of passive investment vehicles like index funds and exchange-traded funds (ETFs) has resulted in the creation of a bubble, similar to US subprime during the 2008 financial crisis, says the investor who was among the few to profit from the meltdown.
In an interview with Bloomberg, Michael Burry said that passive investing has resulted in over-valuation of large-cap stocks which tend to receive a bulk of the investment with such strategies.
Burry, a qualified doctor who turned to investing, was depicted in The Big Short, the Oscar-winning movie based on Michael Lewis' book of the same name.
Burry told Bloomberg that passive investments have led to inflated stock and bond prices – similar to US real estate in the years leading to 2008, fuelled by easy lending by banks, which packaged and sold away below par or subprime loans through complex securities such as collateralised debt obligations.
"This is very much like the bubble in synthetic asset-backed CDOs before the Great Financial Crisis,” Burry said, “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."
Passive investing is a straightforward concept in which investors buy stocks in the same proportion as an index through ETFs and index funds. Passive investing is marked by low costs, emerging as an alternative to active mutual and hedge funds, many of which fail to beat the market after adjusting for costs.
According to data from a report by Vox Markets, ETFs made up 2 percent of US trading volumes in 2000, a number which has sharply risen to 45 percent of all assets in the country’s stock based funds.
But the rise of passive investing funds, which now have assets measuring trillions of dollars, has led to problems of its own. Such funds blindly buy and sell stocks without regard to regard to fundamentals, Burry said.
Given how indexes are constructed, Burry said that the bias of such funds also tends to be towards larger, established companies – something that sidelines smaller companies.
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