Passive investing is all the rage, with more than $500 billion torrenting into companies like Vanguard and Blackrock. Passive investing is typically accomplished with ETFs and/or index funds, which are comprised of all of the stocks within a specific market index. Thus, the funds grow (or shrink) in value at the same rate as the index.
The thought is that this extreme diversification provides investors with (hopefully, usually) low volatility and steady growth. It has also been proven time and again that very few actively managed funds “beat the market” year after year. Across most timelines, passive investors would do as well or better than active investors. That seems like a pretty good argument for index funds.
“Paul Singer Says Passive Investing Is ‘Devouring Capitalism’ – Bloomberg” https://t.co/1Kn2X3jQ96
— Activist Stocks (@activiststocks) August 4, 2017
What Could Go Wrong?
But there are those who do not see things this way. Hedge fund manager Paul Singer is one of the most vocal opponents to this form of investment. Says he: “Passive investing is in danger of devouring capitalism,…There’s a real likelihood that passive investing “and its apparent stability, is unsustainable and brittle.”
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Singer isn’t the only person who thinks this way. Some complain that the meteoric rise of passive investing indicates that the market is no longer rational. If investors are not deeply staked in a single company, what incentive do they have to advocate for the improvement of that company? With ultra-diversified funds eliminate volatility to the point where human investors have difficulty finding deals?
That all may turn out to be so, but there are other ways to explain the state of investment that we are seeing unfold before our eyes.
Passive Investing Isn’t Vulnerable, At Least Not Yet
Even though companies like Vanguard are growing at an astronomical rate, and are invested in around 95% of existing stocks in one or more of their funds, they still only own about 13% of the total number of shares that exist. A 13% stake in the total stock market is nothing to sneeze that, but is a far cry from a majority.
What’s more, companies like Blackrock do push companies to do and be better, as a means of ensuring greater stability and returns for their investors. They do this with corporate governance groups: groups with lobby CEOs and company boards to pursue actions which will be of benefit to every shareholder in a given fund.
There may come a day when passively managed funds represent a majority share of the marketplace. If and when that day comes, aspects of Singer’s critique may be more fitting. But today, coming from a man representing a hedge fund that has not even come close to beating the market in 2017, is not that day. Invest actively if you like, but don’t be fooled into believing that passive investing is a point of vulnerability in the larger investment landscape.