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Can Active Small-Value Funds Save You From Index Overlap?

It's difficult to avoid index overlap entirely.

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Investor Michael Burry, who was featured in the film "The Big Short" and made a killing betting against collateralized debt obligations during the 2008 crisis, recently claimed that the popularity of index funds is creating a bubble. He essentially argues that the flood of money going into equity index funds is creating liquidity risk, with the amount of money linked to many stocks through index funds out of proportion to their daily trading volume. He said that small-cap value stocks are relatively attractive because they tend to be underrepresented in indexes.

At the very least, the bulk of passive U.S. equity assets are indeed tied to large-cap-dominated indexes like the S&P 500 and Russell 1000 Index; even total-market indexes tend to be large-cap-focused. But time will tell whether Burry’s concern is well-founded. Nevertheless, his interview got me thinking about actively managed small-cap value funds and to what degree they own stocks outside of their prospectus benchmarks. That is, if a fund investor did want to avoid index overlap, to what extent could that be achieved? I looked at the 19 small-value funds that Morningstar covers as a sample.

Kevin McDevitt does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.