Spinning off from a discussion on Tesla being viewed as a ‘deep value’ stock by Cathie Wood of ARK Investment, I’m interested to see people’s views on passive investing and its effect on the stock market.
As a brief summary, Cathie and her team view Tesla as a ‘deep value’ stock due to their belief that innovation is a major inefficiency in the market, and therefore Tesla’s future earnings are far higher than investors are pricing in. If you want more detail have a look at her blog post (above link), or listen to her on a Recent ‘Invest like the best’ podcast.
They have this view on numerous other stocks, so try not to get too hung up on Tesla as an example piece (their numbers are debatable, check @CTE thoughts on MaaS in previous post^^) , but Cathie recently wrote an open letter to Elon urging him to keep Tesla public and part of her letter referenced passive investing leading to misallocation of capital, as well as the inefficiency of markets to price in the effects of innovation (listen to her podcast - Nvidia and chip makers is a great example of them getting something like this correct).
So - my discussion topic - do we agree/disagree/have any data that a rise in cap-weighted passive tracker funds is leading to a misallocation of capital?
i.e. that profitable and well run companies, or those with a disruptive edge/technology, are not receiving the stock price they should? And that money is blindly flowing into those who are already on top of indexes such as FTSE100 etc.
Commentary on a potential ‘passive bubble’ has been as interesting as it is complicated.
However, I have to disagree that passive investing has led to underpricing of tech companies - the S&P top 10 is pretty much all tech now, which was certainly not the case 10 years ago. Plus look at Nvidia or Tesla itself - both have enjoyed serious growth.
That argument just seems a little self-serving from a big Tesla shareholder.
I’d be interested to hear other thoughts around the passive approach though - we’re going to be posting about indices and index tracking soon
Yes completely agree re: tech stock valuations. I don’t think passive investing has necessarily caused the explosive growth in them, however it may be part of it. I suppose I’ve managed to combine two threads here again: 1. Passive investing causing misallocation of capital, 2. Innovation as a market inneficiency.
I think more generally if you do have an ETF that is cap weighted and all of a sudden a lot of large institutional investors are weighing in on them rather than with active managers then it will begin to influence the index.
If you have huge pension providers blindly allocating 7% of their funds to HSBC stock because their customers are in FTSE 100 index trackers then it would be logical for this to distort markets, to an extent. Not necessarily causing a bull run, but certainly causing certain stocks to be undervalued and other to be overvalued.
I guess it’s partly dependent on whether you think a) there is a true objective value of stocks which is a very interesting subject
b) if you think that rational prices are more easily found by a smaller pool of more dedicated, possibly more informed investors or just by having as many discretionary pickers in the market as possible.