With more and more passive investments taking over the market, people started to worry about “bubble” due to index fund/ETF, representative people are the stellar portfolio manager in big short in 2008 financial crisis Michael Burry.

His point is that index funds/ETFs could 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 meltdown in 2008.” – He is quite right to point out not only ETFs are taking over significant share itself, but there are numerous derivative products created based on them. Another type of sister product is ETN, purely derivative products but adopt the similar construction process as ETFs.

While there is another portfolio manager/youtuber claimed price discovery due to passive investments only account for 2.5%, hence it’s omittable, there is no need to have fear of index fund/ETF bubble. – I can’t agree with his view because even ETFs do not actively trade everyday as those so called active mangers, the hype and hence more capital pouring into passive funds will cause more ETF units creation, reversely, more redemption in adverse scenarios. You can not ignore the fact money is pursuing passive and claim the price won’t go up.

I have the conviction that market is not efficient, or, how could those quant hedge fund algos are making tons of money?! Passive funds take in the whole market or it’s simple thematic etc. strategy will unavoidably include mediocre stocks into the basket. Hence opportunities present to us to take advantage of these passive funds. 1. prices inefficiency is created by passive funds dominancy; 2. strategies should be designed based on these passive funds flaws instead of traditional single stock.

That’s why recently years, hedge funds are actively recruiting talents in this area.

Back to the argument about if there is index fund/ETF bubble, I conclude if these hedge fund are reaping considerable profits based on the phenomena of passive trend, bubble, i.e. price distortion potentially causing market crash, won’t exist, because they are absorbed/taken in by smart index arbitragers. .