Episode Details

Not according to Michael Burry, the legendary investor featured in the book and movie, The Big Short, who is predicting a 2008-style crash.

American Michael J. Burry is a physician, investor, and hedge fund manager. He was the founder of the hedge fund Scion Capital, which he ran from 2000 until 2008, before closing the firm to focus on his own personal investments.

Burry made a fortune betting against CDOs before the 2008 financial crisis and his estimate net worth is $250 million. He currently manages over $100 million in his own fund.

In an interview with Bloomberg, Burry said index fund inflows (investment money) are distorting prices for stocks and bonds in much the same way that CDO purchases did for subprime mortgages over a decade ago. The flows will reverse at some point, he said, and “it will be ugly” when they do.

“Like most bubbles, the longer it goes on, the worse the crash will be,” said Burry, who oversees about $340 million at Scion Asset Management in Cupertino, California. One reason he likes small-cap value stocks: they tend to be under-represented in passive funds.

Here’s what else Burry had to say about indexing, liquidity, Japan and more. Comments have been lightly edited and condensed.

“Central banks and Basel III have more or less removed price discovery from the credit markets, meaning risk does not have an accurate pricing mechanism in interest rates anymore. And now passive investing has removed price discovery from the equity markets. The simple theses and the models that get people into sectors, factors, indexes, or ETFs and mutual funds mimicking those strategies -- these do not require the security-level analysis that is required for true price discovery.

“This is very much like the bubble in synthetic asset-backed CDOs before the Great Financial Crisis in that price-setting in that market was not done by fundamental security-level analysis, but by massive capital flows based on Nobel-approved models of risk that proved to be untrue.”

“The dirty secret of passive index funds -- whether open-end, closed-end, or ETF -- is the distribution of daily dollar value traded among the securities within the indexes they mimic.

“In the Russell 2000 Index, for instance, the vast majority of stocks are lower volume, lower value-traded stocks. Today I counted 1,049 stocks that traded less than $5 million in value during the day. That is over half, and almost half of those -- 456 stocks -- traded less than $1 million during the day. Yet through indexation and passive investing, hundreds of billions are linked to stocks like this. The S&P 500 is no different -- the index contains the world’s largest stocks, but still, 266 stocks -- over half -- traded under $150 million today. That sounds like a lot, but trillions of dollars in assets globally are indexed to these stocks. The theater keeps getting more crowded, but the exit door is the same as it always was. All this gets worse as you get into even less liquid equity and bond markets globally.”

“This structured asset play is the same story again and again -- so easy to sell, such a self-fulfilling prophecy as the technical machinery kicks in. All those money managers market lower fees for indexed, passive products, but they are not fools -- they make up for it in scale.”

“Potentially making it worse will be the impossibility of unwinding the derivatives and naked buy/sell strategies used to help so many of these funds pseudo-match flows and prices each and every day. This fundamental concept is the same one that resulted in the market meltdowns in 2008. However, I just don’t know what the timeline will be. Like most bubbles, the longer it goes on, the worse the crash will be.”

“Ironically, the Japanese central bank owning so much of the largest ETFs in Japan means that during a global panic that revokes existing dogma, the largest stocks in those indexes might be relatively pro