If you have read Michael Lewis’s The Big Short or seen the movie by the same name may recognise the name Micheal Burry. He is the guy (played by Christian Bale in the movie) who predicted the collapse of the CDO market in 2007/ 08 by actually looking under the hood of these products and seeing that they were built on a foundation of people with poor credit ratings and/or low incomes were getting mortgages to buy properties at discount interest rates. When these discounts expired and they went onto the real, sub prime rate, they would inevitably default and the whole thing would collapse. He shorted the market and his firm, Scion Capital ultimately recorded returns of 489.34% (net of fees and expenses) between its inception in November, 2000 to June 2008. To put that on context, the S&P 500 returned just under 3%, including dividends over that period.
In an interview with Bloomberg at the start of September, Burry warned about the impact that Index funds (passive investing) is having on the markets:
“(Passive investing) is very much like the bubble in synthetic asset-based 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”
I have seen lots of commentary saying that Burry is wrong, that passive investing is not going to bubble like CDOs but I am not sure that is what he is saying. What he is saying is that those who purchase indexes don’t do any fundamental analysis of the price of the underlying shares, they just buy the whole lot. This distorts prices and and he is right. The MSCI World Index holds 1,600 stocks. Who knows what all of those companies are? A Google search doesn’t bring up the list of what is contained in the index, only the top 10, which you could probably guess anyway.
There are fundamental differences between the CDO bubble of the Great Financial Crisis and
At Bluewater, we are a big believer in passive investing. For decades, companies like MSCI have designed indices that give a fair representation of the world stock market which gives investors a cheap way of getting access to the market. We will continue to recommend this approach to clients.
If you have any questions, send me an email at email@example.com
16 November 2020