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according to bloombergElon Musk's current net worth is $205 billion.
But this week, a Delaware judge significantly damaged Musk's net worth, ruling that the compensation package he received in 2018 was too generous and unfair to shareholders.
While there has been much discussion of the judge's ruling in the economic press, there is another important element to the story that has been overlooked. It's also a matter of greater concern to the broader public than how many billions of dollars Musk ends up pocketing after appealing the verdict. I'm talking about the role passive funds played in instigating the drama. If Tesla hadn't risen 743% in 2020, we probably wouldn't even be having this discussion.
When Standard & Poor's announced it would add Tesla to the S&P 500 index in November 2020, it sparked a ferocious stock rally as active investors saw an easy opportunity to get ahead of the impending passive bid. .
That month I wrote an article forbes Title: Do S&P 500 investors really want to buy Tesla now?
This article highlighted how passive investors are ready to buy stocks. rear It was already up 600% year-to-date and 50% in the same month, at a sky-high valuation, which happened to be higher than the entire U.S. energy sector at the time.
Of course, passive investing giants Vanguard and BlackRock bought it anyway because that's their job. Market-capitalization-weighted passive funds always track the stocks whose prices are increasing the most. It's their “investment process”. However, just following price momentum can be a pain.
Since the date of this article, Tesla stock has fallen 4%, lagging 40% of the S&P 500 index's total return. Meanwhile, the S&P 500's energy sector rose 146%.
There is no doubt that Tesla's long-term shareholders are still reaping huge profits. But passive investors who followed the speculative frenzy at the end of 2020 haven't fared much better.
No one benefited more from Tesla's huge stock price rally in 2020 than Mr. Musk. Ironically, even though passive index funds have made Musk the richest man in the world, he doesn't seem to be a fan of them.
During a conference call last week, Tesla likened index fund voting advisor Institutional Shareholder Services (ISS) to the Islamic extremist group ISIS. Mr. Musk has warned that index funds and their corporate governance advisers could become so powerful that they threaten his degree of control over key corporate governance issues at Tesla, his only publicly traded company. He seems concerned.
Many were quick to dismiss Musk's comments because they coincided with his request for a raise from Tesla's board. Essentially, he wants a new compensation plan that increases his stake in Tesla stock to 25%. He argues that this level of ownership gives him enough voting rights to steer the company in the right direction over the long term.
Before you blithely dismiss Mr. Musk's comments as merely self-serving, it would be wise to consider a warning issued by Vanguard founder John Bogle, the godfather of the passive investing movement.
In 2018, the year before his death, Bogle said: “If historical trends continue, a small number of large institutional investors will one day control the voting power of virtually all large American companies. Public policy cannot afford to ignore this growing control. “We need to consider the implications for financial markets, corporate governance and regulation. These will be the big challenges of the future.”
Perhaps Mr. Musk is right to worry.
Currently, the passive ratio of US stock ETFs and mutual funds has risen to 60%. If this trend is not stopped, it will have a major impact on future voting rights. Relatively anonymous corporate governance advisors at companies like ISS and Glass Lewis are among the most powerful in American companies, advising them on shareholder votes at the world's largest companies, which are increasingly owned by passive funds. It could be one of those people.
However, as Bogle suggested, corporate governance is only one of the key issues to consider with market-cap weighted passive funds.
As the composition of our financial system becomes increasingly passive, we are systematically directing capital in ways that disrupt the valuation profiles of the world's largest companies, thereby reducing the security of our investments in the long run. sexuality is declining.
Market-capitalization weighted passive funds invest primarily based on the size of each company. For example, when an investor puts money into a passive vehicle such as a target-date fund or his SPDR S&P 500 ETF (SPY), a large portion of the money (about 7 cents on the dollar) automatically goes to his Apple and Microsoft. It will be passed. World market capitalization companies.
When passive flows become positive, the largest companies can reap significant profits. But when the largest stocks become too expensive relative to their underlying earnings power, future returns are deferred, creating the potential for pesky air pockets whenever stocks reverse direction. .
A notable example of how this works is the Magnificent 7 stocks, a group of megacap tech stocks that includes companies like Apple, Microsoft, Tesla, and NVIDIA. This group of companies was by far the biggest story on the stock market in 2023, rising 107%. But when financial conditions tightened in 2022, the group fell 45%, more than double the S&P 500's losses.
There is growing evidence to suggest that the tendency to passively invest based solely on market capitalization may be distorting stock markets and the economy in other, perhaps unsound ways.
Clearly, the ever-present negative bidding creates an uneven playing field in favor of the largest companies.
A simple way to understand this is: If AI is indeed the next big frontier of technological advancement, why are incumbent tech giants like Microsoft, Google, and NVIDIA expected to be the biggest beneficiaries?
Creative destruction fosters economic development in the long run because it allows new companies with new ideas to quickly create breakthroughs. Also, established companies constantly innovate based on the fear of being forced out. These are good things.
But in today's economy, some tech giants benefit enormously from maintaining the status quo, subsidized by passive investors. Silicon Valley's largest companies have huge balance sheets and enjoy a permanent cost of capital advantage over smaller companies (billions of dollars in incremental monthly payments continue to be generated thanks to passive flows). ). This makes it easy for him to quickly invest $10 billion to beat an upstart competitor or grab pole position on a hot new trend, as Microsoft did last year with OpenAI. benefits of scale.
Another concern about the proliferation of passive investing is how it contributes to wealth inequality.
This point is really simple. Passive funds are designed to unfairly favor the wealthiest companies, which are largely run and owned by the wealthiest people. This partly explains why former Microsoft CEO Steve Ballmer is now trying to collect more than $1 billion a year in dividend checks alone.
Wealth inequality is a global problem. Oxfam, the global federation of NGOs fighting poverty and inequality, publishes an annual report titled Inequality Inc. The report paints a disturbing picture of a widening gap between rich and poor. Since 2020, the wealth of the five richest people has doubled to a staggering $869 billion, but nearly 5 billion people are poorer than they were before the pandemic. Something is wrong.
History has shown that economies work best when economic benefits are widely distributed because capital moves faster. The marginal propensity of a poor person to spend money in small increments is much higher than that of a millionaire.
And when economic benefits are distributed too narrowly, it creates an unhealthy amount of social tension.
Passive investing is more than just an investment style, it's also a story.
One version of this story is that passive investing democratizes investing by reducing fees to benefit the common man.
Another interpretation of this story is that passive investing is akin to economic pollution. Because passive investing taints the free market signals that have traditionally guided capital to its highest and best uses.
Which story do you believe?
Different views on the same thing form markets. Personally, I think passive investing started as a great idea back in the 1970s, but perhaps not anymore because so many people are doing it now.
Bogle was the first to admit that there is a limit to how high passive share can go without negative consequences. We know the cap is below 100% for him, but exactly where it is is an open question.
In December 2023, Musk quipped: At the end of the day, someone has to actually make an active decision. Passive investors are riding on the decisions of active investors. ”
This idea can be seen in a simple metaphor.
Imagine a teacher telling a classroom of students that it's okay to imitate each other on upcoming exams. When the next exam comes, some students stop studying and imitate the students next to them. Since most people in the class are still studying, most people pass the exam.
And when the next exam comes around, fewer students will bother to study.
Then comes the next exam, and only 40 percent of students bother to study.
If this trend continues unabated, it won't be long until the IQ of the entire class drops so much that everyone fails the exam.
We don't want that to happen to our markets or our economy.
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