The strong net inflows into ETFs and other index-tracking products is leading to a “bubble” in passive investing, according to famed investor Michael Burry.
Passive investing has reached bubble territory, according to ‘Big Short’ investor Michael Burry.
Burry – who featured in ‘The Big Short‘ book and film – was one of few investors to recognize the impending subprime mortgage crisis.
By buying credit default swaps against vulnerable subprime deals, Burry’s Scion Capital hedge fund made over $800 million in profit following the market’s collapse in 2008.
Burry appears to have now turned his attention to the passive market, according to Bloomberg.
Whether passive investing has reached bubble territory is open to debate on many levels. The industry has, however, certainly ballooned in recent years.
Reflecting the broader rise of passive investing, ETFs/ETPs globally have recorded a compound annual growth rate in assets under management of 20.1% over the past ten years to reach total AUM of $5.74 trillion, according to ETF industry consultant ETFGI (data as of the end of July 2019).
In contrast to his bearish views on the subprime mortgage market, however, Burry has not explicitly stated that the so-called bubble in passive investing is leading to a market collapse. Instead, he notes that the growth of passive investing, which tends to favour large-cap stocks through an abundance of market cap-weighted indices, is leading to opportunities in smaller-cap stocks which are being neglected.
According to Burry, as quoted on Bloomberg, “The bubble in passive investing through ETFs and index funds as well as the trend to very large size among asset managers has orphaned smaller value-type securities globally…there is all this opportunity, but so few active managers looking to take advantage”
Active vs. passive
Burry’s remarks add to the ongoing ‘active versus passive’ debate, which has, at times, become quite heated.
In 2016, analysts at research and brokerage firm Sanford C. Bernstein & Co labelled ETFs “worse than Marxism”, stating that “a supposedly capitalist economy where the only investment is passive is worse than either a centrally planned economy or an economy with active market led capital management.”
Bernstein argued that although passive funds may be cheaper, they cannot drive economic growth by allocating resources to companies and entrepreneurs that need it or force change at companies by withholding investment.
However, supporters of ETFs believe that the growth of passive investing is actually positive for active management and should be viewed more as an opportunity than a threat.
A November 2018 research paper from Lyxor Dauphine Research Academy, a joint initiative between Lyxor Asset Management and the University Paris-Dauphine House of Finance, found that passive funds have helped investors by increasing competition in asset management. Specifically, the increasing availability of smart beta funds has forced active managers to demonstrate that they can deliver true alpha in order to continue to gather flows.
More recently, concerns relating to potential liquidity and counterparty risks in ETFs were brought up in the European Central Bank’s semi-annual Financial Stability Review.
The European Fund and Asset Management Association (EFAMA) were quick to calm the unease, however. The Brussells-headquartered investment industry association points to how ETFs have fared well during bouts of significant volatility, adding that the ‘often overlooked’ indicator of ETF liquidity – the depth of the secondary market – provides them with an extra level of resilience compared to mutual funds.