Would passive investing in ETF/Index funds be the next bubble?

Woke up this morning thinking of the recent hype about passive investing through index/ETFs.

With the recent “advice” by Warren Buffett on it’s better to invest in ETFs rather than an active manager, pretty sure that there will be a greater inflow of funds into ETFs, causing a short-term momentum up. The theory of reflexivity also explains that this will further push the price up. It has also been brought to my attention that with that, many more retail investors might put in more money into ETF esp S&P500.

The impact for this is that there will be a widening difference in valuation between stocks in the S&P 500 and those that aren’t. Companies in the S&P500 will just get pricier. And the bubble might burst once a crisis hit or a bad earnings quarter and investors start to flee the ETFs. Because of their fund structure, it’s not easy for the ETF to exit and they will lose money due to the volatile spreads happening in a crash, causing the index to fall further.

And one thing about Warren Buffett, sometimes his words are different from his actions. He did not invest in any index/ETF funds. Do what he does but not what he says.
What are your thoughts on this?

 

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1 Comment

  1. I was thinking the same thing myself. I recently read Joel Greenblatt’s book, the Big Secret for the Small Investor. He explains how many market cap weighted indexes and ETFs are systematically doing the wrong thing. I wrote a summary over on my blog if you want to check it out.

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