The Rise of Passive Investing: A Threat to Active Money Managers?
Hedge-fund titan David Einhorn warns of the challenges faced by active money managers in the era of passive investing
The dominance of passive investing has been steadily growing, leaving active money managers grappling with a changing landscape. In a recent interview, hedge-fund titan David Einhorn expressed his concerns about the rise of passive investing and its impact on the value industry. As more investors flock to passive funds, the traditional approach of active managers is being challenged, leading to a vicious cycle that further erodes the value sector. This article delves into Einhorn’s insights and explores the implications of passive investing on the market.
The Broken Markets and the Rise of Passive Investing
Einhorn argues that the markets are fundamentally broken, with passive investors lacking an opinion about value and instead focusing solely on price. The influx of machine money and algorithmic trading has further amplified this trend, as these strategies prioritize short-term price movements rather than long-term value. As a result, the value industry has suffered significant setbacks, struggling to attract investment as money flows towards passive funds.
The Vicious Circle: Redemptions and Value Stock Decline
As active managers face redemptions, they are forced to sell their holdings, causing value stocks to plummet even further. This downward spiral triggers more redemptions, exacerbating the problem. The irony is that the stocks that perform well are often overvalued assets that receive flows from index funds. As money is withdrawn from value and poured into index funds, active managers find themselves buying more overvalued assets, leading to a divergence from value rather than a reversion towards it.
Adapting to the Shift: Greenlight’s Strategy
Einhorn acknowledges that his own hedge fund, Greenlight, had to adapt to the changing market dynamics. They have made significant changes to their investment approach, no longer willing to pay high multiples for stocks based on expected earnings growth. With the apathy prevalent in the market, where investors fail to notice or care about earnings improvements, Einhorn emphasizes the need to find undervalued stocks with low earnings multiples. By investing in companies with solid balance sheets and low leverage, Greenlight aims to capitalize on the potential for stock buybacks and cash returns, which can drive stock prices higher over time.
The Future of Active Management
Passive investing has reached a significant milestone, with passive exchange-traded funds and mutual funds surpassing active funds in terms of assets. However, Einhorn believes that there are still opportunities for active managers. With the market’s focus shifting towards passive investing, there may be overlooked value propositions for astute investors. By identifying undervalued stocks with the potential for buybacks and cash returns, active managers can create value for their clients, even in a passive-dominated market.
Conclusion:
The rise of passive investing has undoubtedly posed challenges for active money managers. As more investors embrace passive strategies, the value industry has suffered significant setbacks. However, David Einhorn’s insights suggest that there are still opportunities for active managers to thrive. By adapting their investment approach and focusing on undervalued stocks with the potential for stock buybacks and cash returns, active managers can navigate the changing landscape and deliver value to their clients. The future of active management may lie in uncovering hidden gems in a market dominated by passive investing.