Howard Marks Speaks: Where Does Passive Investing Go From Here?

Here, Marks gets to the question I’m asking these days:

What percentage of assets has to be actively managed by investors driven by fundamentals and value for stocks to be priced “right,” market weightings to be reasonable and passive investing to be sensible? I don’t think there’s a way to know, but people say it can be as little as 20%. If that’s true, active, fundamentally driven investing will determine stock prices for a long time to come. But what if it takes more?

Passive investing is done in vehicles that make no judgments about the soundness of companies and the fairness of prices. More than $1 billion is flowing daily to “passive managers” (there’s an oxymoron for you) who buy regardless of price. I’ve always viewed index funds as “freeloaders” who make use of the consensus decisions of active investors for free. How comfortable can investors be these days, now that fewer and fewer active decisions are being made?

Certainly the process described above can introduce distortions. At the simplest level, if all equity capital flows into index funds for their dependability and low cost, then the stocks in the indices will be expensive relative to those outside them. That will create widespread opportunities for active managers to find bargains among the latter. Today, with the proliferation of ETFs and their emphasis on the scalable market leaders, the FAANGs are a good example of insiders that are flying high, at least partially on the strength of non-discretionary buying.

I’m not saying the passive investing process is faulty, just that it deserves more scrutiny than it’s getting today.

Ackman, an activist investor, takes the argument further than Marks, saying that passive investment gives bad management teams a free pass and suggesting that, if present trends continue, the American economy will start to resemble that of Japan or South Korea. In Japan, the keiretsu system of cross-corporate ownership dominates large public companies and has been cited as a reason for the country’s lack of competitiveness.

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Disclosure: I also happen to be long OAK .

Disclosure: Charles Sizemore is the author of the Sizemore Insights ...

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