No doubt, Passive investments via Index funds have fulfilled the dreams of retail investors to own all big companies with very small capital. By passive investments, I mean, we can invest in Index funds that follow a certain index, and the pooled amount will be invested in constituents’ shares of that index.
For instance, lakhs of small retailers want to invest in the biggest 50 companies in India, which are part of the Nifty 50. But to invest even in 1 share of each of those will cost around ~Rs.1,34,200; which is a very big amount to go with. • Index funds solve the exact same problem, it pools money from mass and invests in these 50 companies. So by a very low amount as low as Rs. 180-200 one can easily own all those big stocks.
So are Index funds really good investments or is it just a hype/bubble so to say? Interestingly, 2 very well admired sharks on Wall Street have extreme contrarian opinions. Let’s dive into it.
Warren Buffet on Index Funds –
Mr. Warren Buffet very aggressively promotes the index funds. He advises going for index funds and suggests it to be the best strategy to go for as markets always tend to go up over a longer duration. He has never recommended his own company’s (Berkshire Hathaway) shares to anyone, but he has several times exclaimed the index funds.
On the contrary, in The Big Short, Dr. Michael Burry is against the index funds claiming it to be a bubble, and advises to stay away from it.
(Mr. Michael Burry is well known for his short position in the 2008 housing market crisis in the USA and had earned a fat profit out of it)
But why does Dr. Burry say it’s a bubble?
In an interview, he stated the reason as….
So when tons of people invest in an index fund, pooled funds are getting invested in those companies without actual evaluation of those companies. He compared the same with synthetic CDOs where big inflows had happened without fundamental checks in the 2008 crisis. So there’s some external force influencing the prices of stocks other than underlying business performance. And that’s the formation of bubbles i.e. when share prices move other than due to business fundamentals.
Imagine a company is not currently doing well, but just because it has a place in a particular index, then in spite of the bad shape of the company, constant inflow in shares by passive funds will deviate its share price from its intrinsic or real value. As we have seen Adani is trading at exorbitant valuations, still Adani Ports, being in Nifty 50, you’d end up owning it.
Inflows in shares of companies (from Passive funds) without regard to their fundamentals will hamper the True Price Discovery of those shares.
And he is NOT WRONG!
It’s a very odd situation that both sides’ opinions are valid. It’s your ultimate decision how you look about it..
(I’m on Warren Buffet’s side this time)
– Team Arthology
Nice article got to know both sides of the fund