LAST WEEK, investment manager Michael Burry made waves when he issued an apocalyptic forecast: Index funds, he said, are in a bubble similar to the housing bubble that ended very badly in 2008. Burry couldn’t say when the crash would come, but noted ominously that, “the longer it goes on, the worse the crash will be.”
Burry acknowledged that he’s “100% focused on stock picking,” so—at first glance—his criticism seems not unlike other active fund managers’ criticisms of index funds, sometimes referred to as “passive investing.” Competitors have been lobbing grenades at indexing since its inception nearly 50 years ago, when one active manager called index funds “un-American.”
But Burry isn’t just any ordinary stock-picker. He’s a cult hero within financial circles. A neurologist by training, Burry left medicine to start a hedge fund and was one of a handful of investors to predict the 2008 crash in mortgage bonds—and to profit from it. In The Big Short, his book on the topic, Michael Lewis cast Burry as a central character. In short, Burry is exceptionally talented, with a track record that speaks for itself. It’s no surprise then that last week, when he issued his broadside against index funds, people listened.
In Burry’s view, the growth of index funds presents several dangers. First, they use derivatives, “the same fundamental concept that resulted in the market meltdowns in 2008.” He cautioned that index funds could face a liquidity crunch. “The theater keeps getting more crowded,” he said, “but the exit door is the same as it always was.”
That last line was the one that really got people. No one likes the idea of being stuck, especially when it comes to one’s finances. And no one likes the idea of getting caught in a stampede.
While I disagree with Burry’s doomsday forecast, I’d like to discuss a broader issue here. My peers Allan Roth and Ben Carlson have done, I think, the best job of responding to Burry’s comments point by point. Vanguard Group also addresses some of Burry’s criticisms in this paper. I recommend reading what they have to say.
The broader issue, in my view, is our propensity as humans to buy into narratives like Burry’s. As Jonathan Gottschall wrote in The Storytelling Animal, “We are, as a species, addicted to story. Even when the body goes to sleep, the mind stays awake all night, telling itself stories.”
Writing in Thinking, Fast and Slow, Daniel Kahneman says that, “The confidence that individuals have in their beliefs depends mostly on the quality of the story they can tell about what they see, even if they see little.” In his experiments, Kahneman has proved that most people prefer stories and intuition over facts and data.
This, in fact, is how people accomplish memory feats like reciting thousands of digits of pi. No one can remember all those numbers, but they can remember stories. They build mental images, and associate numbers with stories, as they walk through those landscapes in their mind.
In short, a story is a potent tool. And the more sensational the story, the better. Data is hard, but stories are easy.
In reading Burry’s warning about index funds, I’m not sure most readers would follow his logic. After all, it’s a complicated topic and most people don’t have ready access to the same data. But his image of the stampede at the movie theater? Everyone can understand that. Indeed, that’s why I think his comments got so much attention.
Stories aren’t necessarily all bad. But as an investor, it’s important to discern fact from fairy tale. Here are some tips:
Adam M. Grossman’s previous articles include Adding Value, Three Risks and Room to Disagree. Adam is the founder of Mayport Wealth Management, a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter @AdamMGrossman.
Do you enjoy HumbleDollar? Please support our work with a donation. Want to receive daily email alerts about new articles? Click here. How about getting our weekly newsletter? Sign up now.
I’ve been following scary index fund stories since the mid 90’s and speaking of telling stories, the WSJ is one of the best. A 30 Jan 1997 article complained about companies getting a (temporary) price bump with their inclusion in the S&P 500. The story: imagine a shopping mall where any new store opening guaranteed sales. My thought was fine, but the new store is required to prove worthiness for acceptance into the mall and if they don’t grow their business, they’re going to be displaced by someone that is.
The takeaway from the Vanguard article for me was that index fund investors are not monolithic buy-and-hold as assumed by the dooms day prophets, a large portion are using these funds for active strategies. Apparently human emotion is not going out of style. Something else not mentioned in the article is that even though the percentage of ETF’s relative to mutual funds are relatively small at present, they are growing at a much faster pace. ETF’s with their stock like trading characteristics are traded at higher velocities than mutual funds. I think we’re gonna have to perpetually post date the index fund apocalypse.
Vey well written. #3 is one of my favorites – making sure I stay open to other’s interpretations of the data.
Check out what MMM has to say about the ‘problem.’ https://www.mrmoneymustache.com/2019/09/12/michael-burry-index-funds/
Is there a follow up story to this about Michael Burry? Many naysayers continue to put down index funds. I’d rather index than follow the herd.
Saying outrageous things gets Wall Street experts attention. But those experts are rarely called back later and asked to explain their ridiculous comments.