Michael Burry says it's skewing the market
The SPY might be the greatest financial innovation of the 21st century.
It created the opportunity to essentially own the entire S&P 500 in a single transaction with an expense ratio of 0.09%. Others have withered the expense even lower but the SPY ETF remains top dog with $241 billion piled into it. Rivals IVV and VOO are the second and fourth largest ETFs with $234 billion combined.
Buyers have been rewarded handsomely with a 13.87% annual return over the past decade. Stat after stat has shown that managers rarely beat the index. Moody's expects more money will be in index funds than under active management by 2021.
Buying it has become a religion.
I hesitate to call it a bubble because the underlying assets are fine. The SPY might fall 10-20% if the economy slips but that's hardly a bursting bubble. At the same time, all bubbles are different and passive is a different kind of skew. It's not so much inflating an asset as distorting all related assets.
An example right now is the S&P 500 compared to the Russell 2000.
You would expect the Russell to outperform in a trade war because the companies are more domestically focused but it's the large caps that are winning out and many are pointing to passive as the reason.
One is Michael Burry, who made fortune in fame as one of the characters in The Big Short.
"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,"Burry told Bloomberg.
The trend has also contributed to the outperformance of growth over value.
I believe it's also leading to USD inflows. The long-term track record of the US market is virtually unbeaten globally and it provides much more diversity than any other index and the assets are held in the world's reserve currency. It's very easy to be overweight US stocks if you're a global investor. In addition, all the best country-specific ETFs are on US exchanges priced in USD. At the very least that creates a flow-through and an incentive to hold US dollars.
Ultimately, the dislocations create opportunity that value investors will eventually exploit -- Burry is looking at the South Korean market, which is trading at an 11.73 P/E compared to 21.5 in the S&P 500.
Fighting it may eventually prove to be the right trade but for now it's still the early stages and money will continue to flow out of hedge funds and into passive, boosting the US dollar with it.
