Think for Yourself by Vikram Mansharamani

Author:Vikram Mansharamani
Language: eng
Format: epub
Publisher: Harvard Business Review Press
Published: 2020-06-16T00:00:00+00:00

Passive investing is good generalist logic. You can’t know everything, so why not own everything? But with the explosion of indices, each one narrower than the last, the logic breaks down. Are you really getting the benefit of passive investing when you invest in an index that tracks small cap biotech companies listed on emerging market exchanges but excluding state-owned enterprises or companies that begin with the letter w? It’s now possible to invest in the Obesity ETF, SLIM, which tracks the performance of companies positioned to profit from servicing the obese, more than 40 percent of which is invested in two companies; narrow ETFs such as these (and others) may prove useful for speculation, but let’s not think they’re good passive index investments.

The irony is that the logic that makes passive investing a good idea falls apart when too many people start to do it. Think about it. Imagine a world in which everyone is investing passively. All stocks would rise or fall depending on inflows or outflows. Both good and bad companies would rise with inflows and fall with outflows. The premise that prices are accurate, the foundation upon which the argument in favor of passive investing lies, breaks down. Systems thinkers will not find this shocking.

Prices lose their grounding if everyone invests passively. The blunt reality is that passive investment involves buying and selling stocks without considering their price. Stop and think about my last sentence. Does that make sense? Would you really want to buy and sell securities without considering their prices? We’re now seeing a drop in active investing overall, which I think is a worrying trend. We want people paying attention to prices! And in fact, it’s the active investment community that helps push prices toward their fair values. Without active investors, price discovery processes break down.

Grant describes this phenomenon with respect to fixed income ETFs, which have ballooned in recent years: “Assets which used to be subject to scrupulous credit checks … now sit in one-click wonders and, as volatility has steadily fallen, so has the quality control around the bonds which make it into ETFs.”13 Back in 2010, only 20 percent of companies in the S&P 500 had Vanguard index funds with a significant ownership stake (5 percent or more); since then, the number of companies in which Vanguard (and its peers BlackRock and State Street) own meaningful stakes has risen.14 As fewer people actively choose which companies to invest in, I’m afraid that we’ll see the market become more volatile. As the report showed, stocks with the highest passive ownership were more vulnerable to price swings because fewer shares were available for trading.

In many ways, investing successfully over the long term is about thinking for yourself and ignoring the noise. It’s about being a contrarian and understanding that most people do not think for themselves, allowing financial media houses to manage their attention. Push back on the allure of hot stocks and the Mad Money–inspired investo-tainment industry … and think for yourself about what makes sense for your risk tolerance and personal objectives.

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