Just as in 2008, a lot of money is being invested in instruments with little or no disclosure that investors do not even understand. From Tyler Durden at zerohedge.com:
While there has been extensive discussion of the passive/ETF/index fund bubble, most recently by Michael “Big Short” Burry, who most recently joined the parade of skeptics warning of the implicit and explicit dangers the passive investing bubble carries with it, perhaps the most interesting angle of the ETF stampede into fixed income securities – which include junk bonds and leveraged loans in addition to the recent frenzy for investment grade debt – is the fact that a substantial portion of it now trades with virtually no fundamental information. In other words, assets are being bought (if not so much sold) simply to accommodate the flood of investor money, with no regard for actual financial data or corporate newsflow.
This is highlights in a recent note by TCW’s Chief Investment Officer of Fixed Income, Tad Rivelle, who currently manages some $170 billion in AUM, and who writes that as a result of the above, “not only have the debt markets ballooned in size, but the growth has come disproportionately from those segments of the debt market where financial disclosure is poor.”
As a result of this, Rivelle observes that “If democracy dies in darkness, so does liquidity in that embodiment of economic democracy, i.e., the capital markets.” His conclusion is jarring: this lack of underlying information, while ignored when the tide is rising, leads to an immediate collapse in liquidity when the selling begins and results in a scramble for information, to wit:
When information is scarce, investors must color in between the lines. That which is not known nor well quantified must be assumed or modeled. The door is therefore open to different investors reaching quite different conclusions about the underlying value of an asset leading, of course, to illiquidity.
His conclusion is eerily similar to that of Burry: “the rise of portfolio trading suggests to us that passive funds have, heretofore, played an outsized role in the supply of market liquidity.” Yet while passive investing dominates on the upside, or when stocks are rising, what happens when selling commences is a liquidity discontinuity that leads to unprecedented gaps lower as passive investors are unable to discover price once there is demand for actual underlying fundamentals.