Hedge fund titan David Einhorn argues that the seemingly inexorable rise of passive investing is making things tough for active money managers. The remarks were made by Barry Ritholtz, co-founder of Ritholtz Wealth Management, in an interview on the Masters in Business podcast.
“Most investment funds out there don't take value into account. Machine money and algorithmic money don't have an opinion about value, they have an opinion about price. “What will the price be in 15 minutes? Or I want to go beyond that,” he explained.
While active management remains, “the value industry has been completely decimated,” he said.
That can create a vicious cycle. As money moves from active management to passive management, value managers are being forced to respond to redemptions. They then sell their holdings, which causes value stocks to fall further and trigger further redemptions, Einhorn explained.
“Suddenly, the people who are outperforming are the ones who own overvalued things that are getting flow from the index. When you take money out of the value and put it into the index, they sell the cheap stuff, “You end up buying the highest multiples and the most overvalued stocks with a disproportionate weight,” he said.
Active managers participating in that part of the market then capture the flow and buy more of the overvalued assets.
As a result, stocks do not “move back toward value,” but rather “move away from it,” Einhorn said. “This is a shift in the market, and its structure means that about the best way to drive stock prices up is to start with them being overvalued.”
Einhorn said it took Greenlight time to adapt to the change.
Einhorn said the company has made significant changes.
You can no longer pay 10x earnings for a stock in the hope that earnings will improve by 15%, and Greenlight could earn a 13x earnings multiple that would give you 50% earnings in a year and a half. can. The reason is that with the rise of passive investing, “no one pays attention that the return was 15% better…If no one notices, no one is there, no one buys, no one cares” “I guess so,” Einhorn said.
But that “total indifference” in the market means it no longer needs to pay 10 times the return to profit from the same situation, he said. An investor could now earn 4x or 5x his return in the same scenario. And if investors pay 4-5 times earnings and balance sheets are not leveraged, companies should be able to return cash and buy back 10-20% of their stock. That means after four or five hearings, either stock will be gone or prices will go up, he said.
“So you're literally looking to the company to make that happen, not other investors,” Einhorn said.
According to Morningstar, the milestone year of 2023 ended with passive exchange traded funds and mutual funds having more assets than passive funds.
The iShares S&P 500 Value ETF IVE, which tracks the S&P 500 Value Index, is up 0.8% year to date in 2024, and the S&P 500 SPX is up 4.8%, marking Wednesday's eighth-highest closing price of the year. Value ETFs rose 19.9% in 2023, while the S&P 500 index rose 24.2%.
