Why Index Funds Are Like Subprime CDOs

Re:Why Index Funds Are Like Subprime CDOs by beat on Wednesday September 04, 2019 @01:40PM (#20879550)

The more interesting question is, if there is an index fund crash, will the actively managed funds benefit from it, or crash right alongside the index funds? How much are actively managed funds contaminated by stocks that are in index funds? (That probably depends on the type; a small-cap or emerging markets managed fund will probably be mostly clean of the indexed stocks, but a managed large-cap is probably full of them.)

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Re:Why Index Funds Are Like Subprime CDOs by strstr on Wednesday September 04, 2019 @02:01PM (#20879781)

There’s a clear narrative in favor of actively managed funds: they analyze the underlying stock and avoid stocks that are overvalued according to their fundamentals, and buy those that are undervalued.

The consequence would be near total avoidance of the S&P 500 as a good strategy for the long run. There would be exceptions for those stocks that are quite undervalued, or so overvalued that they are worth shorting (despite the tailwind of index funds).

Don’t worry, strategies like these have predicted 12 out of the last 5 asset bubbles.

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Re:Why Index Funds Are Like Subprime CDOs by beat on Wednesday September 04, 2019 @02:11PM (#20879881)

Right. Which begs a question... are the large-cap stocks that dominate the index funds overvalued relative to their fundamentals? That should be easy enough to determine, and we should see a lot of "hold" or "sell" from the analysts.

And if they're not overvalued, are index funds really a bubble?

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Re:Why Index Funds Are Like Subprime CDOs by kgwgk on Wednesday September 04, 2019 @03:19PM (#20880514)

> and we should see a lot of "hold" or "sell" from the analysts.

That's not how that works... Sell-side analysts have a systematic bullish bias, that's what they are paid for.

https://www.bloomberg.com/opinion/articles/2017-01-20/wall-s...

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Re:Why Index Funds Are Like Subprime CDOs by jandrewrogers on Wednesday September 04, 2019 @02:58PM (#20880320)

The concept of "overvalued" assumes a valuation model that everyone agrees on. Large companies are complex organisms and equally complex to value. It follows, with ample evidence, that simple reductionist valuation models based on P/E, book value, and other easy-to-obtain numbers are going to be inadequate. And most valuation models are terrible at incorporating myriad risks.

Currently, I would argue that some large caps are clearly overvalued but others are also clearly undervalued, based on my own valuation model. The indexes are almost always a mixed bag but I buy individual large caps so that doesn't concern me much. It is rare for the entire market to become overvalued, in which case the smart move is not to buy in.

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Re:Why Index Funds Are Like Subprime CDOs by beat on Wednesday September 04, 2019 @03:04PM (#20880359)

I wouldn't say simple reductionist valuation models are inadequate... just incomplete. Most of the time, a deeper analysis should be in line with rule-of-thumb tools like P/E. This is even more true for large companies that value not-losing over winning big.

If you can come up with a clever valuation mechanism that can reliably outperform the well-understood mechanisms, then enjoy pocketing the profits!

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