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Comment by FabHK | Hacker News Reader

> if the indexs see a sell off they won't find the liquidity in the market to cash out their positions and will drive the market down

When investors sell that amount, it doesn't matter whether they hold the underlying assets directly, or via index funds or ETFs, or via actively managed funds. The market will go down. So, which part of the problem is uniquely due to index funds?

Burry hasn't made that point very clear.

There might be issues with (liquid) index funds that give exposure to inherently less liquid assets, such as bonds or real estate. There might also be issues with index funds that do not hold the assets themselves, but replicate the exposure synthetically by entering a swap with a third party, giving rise to tracking error, counterparts credit risk, etc.

However, as I said, Burry hasn't enunciated these concerns very cogently (at least in the extracts quoted by Bloomberg). This article here does nothing to address those concerns.

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Requirement to sell across the board seems to be the unique issue.

They aren't required to sell, unless fund-holders are selling their ETFs.

If those fund-holders were owning the stocks directly, instead of ETFs... Those same fund-holders would be... Selling their stocks. Causing the exact same downward price pressures.

If I sell my ETF, the AP buys it from me, and gets to redeem it for a basket of shares of fixed proportion.

Suppose stock X gets 1% in that basket. The issue is if stock X happens to be very illiquid, the APs selling stock X could drive down the price.

In a non ETF, managers could decide to relatively slow down the sale of X, to prevent crashing the price. However, in an index fund the mechanism dictates all stocks are sold in the same proportion.

An evil mirror universe twin of you, instead of owning an ETF, owns a bunch of shares of APPL, a bunch of shares of GOOGL, a bunch of shares of stock X.

If you are panicked, and are selling your ETF, your evil twin is panicked, and selling all their stocks.

This causes the exact same downwards pressure on the market.

I don't buy an ETF because I want someone to do financial malarkey with my money. I buy it because I want to own stocks, and I can't be assed to deal with my own brokerage account. Besides the convenience aspect, there is zero difference between the two.

Unless everyone has an evil twin, there is less chance of everyone wanting to exit X at the same time. Hence there won't be a run on X.

Moreover, if my evil twin a) owned a managed fund or b) sold in a slightly smarter way, then they would lose less on X due to liquidity.

Moreover, the hit on Xs price also has a slight hit on the ETF value. Hence there is a small positive feedback loop.

Everyone thinks they will be smart about their panic-selling when a market crash hits, but the reality is, most of them won't be... And the decision you should be making is not when to sell, but 'how much to buy'.

The argument is that the automation at scale that ETFs bring to the table changes the game qualitatively. How many people would really buy and sell thousands of individual stocks in a correlated fashion if this infrastructure didn’t exist?

No, they'd have a dozen individual stocks that they would own, and when you combine fifty million people, each owning a dozen individual stocks, you'd get a pretty accurate proxy for the S&P 500.

They'd still follow the same herd mentality that they would, had they owned ETFs.

Authorized participants arbitrage all day, if they see dislocation they can certainly hold on to certain names.

Arbitrage (as done by APs) is mostly about gathering an instantaneous spread. Much like market makers, that strategy is not about holding a position.

Yes, but strategies change in a crash. It's possible no one learned from the 2015 flash crash, but I bet a lot of smart funds out there are ready for one. If a dumb AP is going to put out a crazy price someone is going to be there to snap it up.

But people would see that the best bid is too low, so they would hold that part of their portfolio. (Because there's no point in realizing that huge loss.)

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