WSJ is out with a post calling stock picking a “dying business” and declaring passive investing the winner. And the facts about money flows are on the Journal’s side, but as usual, they are greatly exaggerating things by posting data out of context.
Over the three years ended Aug. 31, investors added nearly $1.3 trillion to passive mutual funds and their brethren—passive exchange-traded funds—while draining more than a quarter trillion from active funds
As Howard Lindzon would say “there’s no such thing as pure passive investing, just fifty shades of active investing”. What’s more interesting to me are the potential consequences of this rising passive investing tsunami:
1.The more money flows to passive investing, the faster markets are likely to become. This will lead higher correlations among stocks and more volatility, which means bigger and quicker corrections; it also means bigger and quicker recoveries. Take a look at the bear market of 2000-2002. As harsh as it was, there were plenty of stocks the kept making new all-time highs during that period and delivered some real alpha. Then, compare it to the correction in 2008, 2011, even early 2016. We saw a lot higher correlations during the most recent corrections. Most stocks went down together; then, they recovered together. Is it a big surprise then if leveraged ETFs are becoming the weapon of choice of more and more active traders?
2. More opportunities for savvy stock pickers. A rising wave (bull market) will lift all boats, including the crappy ones, creating multiple great short targets. A swift correction will bring down strong businesses to super-attractive valuations.
3. A decrease in hedge funds’ fees. 1 & 10 might become the new 2 & 20. If you find a great money manager, 2 & 20 is a small price to pay, but the majority of investors are likely to demand and try to negotiate lower fees. Finding a great money manager is like finding the next Amazon before it happened. The trouble is that in most cases, people won’t stick long enough to see a big difference.
