The Big Short investor, Michael Burry, who predicted the 2008 financial crisis, is now predicting that passively managed ETFs are the next bubble. He’s comparing them to the Collateralized Debt Obligations (CDOs) which were the main cause of the market meltdown of 2008-2009. Should we be worried? Maybe….
How Are ETFs a Bubble Exactly?
Thanks mainly to the followers of this blog and my totally original idea of ETF investing, ETFs and passively managed index funds are exploding in popularity. People are recognizing the value of low cost, diversified investing. Even mutual funds can’t keep up with passively managed index funds.
So what’s the problem? Essentially Burry is saying that investment decisions are no longer based on the underlying stock fundamentals, but rather on their position within an index. In other words, your ETF picks stocks because of their size in the market, not because the business are necessarily profitable. (For clarification, they are picked based on their market cap, not price. Market cap being the value if you multiply the number of outstanding shares by their share price)
To Burry’s credit the situation he’s describing does somewhat resemble the CDOs in 2008. Everyone was buying these CDOs without realizing their contents were utter garbage. Today the garbage is businesses, rather than mortgages in 2008.
Is he right? Sort of, first lets consider the implications if he’s right: