Home / Analysis / ‘A kind of hitchhiker’: passive a parasite on active

‘A kind of hitchhiker’: passive a parasite on active

While passive investment strategies are now used to manage the majority of equities, the absence of active managers would only create a "mindless boom and bust."
Analysis

While the debate about the benefits of passive investing vs active investing continues to rage (despite long-term performance data that ought to have settled it) Oaktree Capital founder Howard Marks believes the relationship is more complex – and more parasitic – than passive investors realise. Active managers do the hard work of price discovery; ETF providers take their word for it.

“The flaw in passive investing is that you have to view it… as a kind of hitchhiker, a free rider on the market. There are 1000 people out here doing active investing and distilling all the information and thinking about the future of the company and thinking about the fairness of the price, and the result is the market price,” Marks said.

“… And then there are ten people over there who run index funds, and they just buy at the market prices because they think those prices are probably fair, or the best you can do, so why go to all the trouble and expense of doing fundamental analysis?”

The problem for Marks arises when the number of people doing fundamental analysis dries up, and the ratios reverse; 1000 people start free riding on the efforts of ten. Then the potential for a divergence between price and fair price increases, and that free ride is not as easy to get or as risk-free as before. Active investing is no good, Marks says; passive investing works better, but only if people keep doing active investing.

“This is a conundrum; the less people invest actively, the greater scope there is for price to diverge from value,” Marks said. “In theory, it becomes easier to find bargains and overpriced securities, and the return from active effort rises. So that’s the irony.”

Marks says that while passive investing is here “in a big way”, algorithmic investing à la Renaissance Capital is yet to make as big a splash as it could. But he’s skeptical that the next revolution some quants prophecise – the complete replacement of human investors with artificial intelligence or machine learning- will ever materialise.

“I don’t think the essence of the business plans or the CEOs can completely be converted into data and input into the computers,” Marks said. “I’m not an expert, but I wouldn’t think computers can make those qualitative subjective judgements better than the best people. Now clearly, not every person can do those things either.”

“… But I don’t think computers will be able to do it. To me, the key conclusion… is that computers can outperform most people, but not the best people. If so, there will still be room in active investing for the best.”

Lachlan Maddock

  • Lachlan is editor of Investor Strategy News and has extensive experience covering institutional investment.




    Print Article

    Related
    Being selective, risk aware, flexible critical in today’s markets: Ninety One

    While the repercussions from ‘Liberation Day’ are still playing out, there can be little doubt it’s a more complex investment environment in which macro conditions, policy actions and asset-level fundamentals will interact in increasingly idiosyncratic ways.

    Ninety One Investment Institute | 24th Apr 2025 | More
    Turbulent markets will suit commercial real estate: Analysts

    Listed property, which found investor favour in 2024, is better positioned to weather market volatility with institutions eyeing improving valuations and development opportunities. For overseas players, a weaker Australian dollar is a bonus.

    Duncan Hughes | 28th Mar 2025 | More
    Investors on red alert despite inflation being tamed: Atlantic House

    Central banks have performed admirably to get economies back on track, but a public that is far less-trusting of big institutions and traditional asset classes remains unconvinced. US President Donald Trump’s trade policies are simply fuelling their fears.

    Nicholas Way | 21st Mar 2025 | More
    Popular