Price discovery in the era of indexed ETF's
The debate between active versus passive investing has been around since I started in the business 30+ years ago. However, after reading this article in the WSJ, I would like to discuss not whether
active management is dead, rather why it is imperative to maintaining an orderly market. As an active manager I only own a small portion of the Russell 2000 companies, and like most, I have very definitive valuation parameters on those companies. Therefore, I am not always a buyer or seller of our positions ex assets flowing into or out of our portfolios. Obviously buy and sell decisions of indexed ETF's are driven only by flows. The managers do not care about valuations. This is why we have seen such high volatility in small cap value in the past 6 weeks, as there are not necessarily willing buyers or sellers when the flows into the ETF's cause demand or supply. I always think about the what the end game is when I am evaluating a concept or idea. If 100% of equity assets were indexed, then theoretically all moves in stock prices can be explained by flows into and out of those funds, without regard to value. In essence, it is like taking the brakes off of a car. I believe that active management not only provides an opportunity for Alpha, but also provides a mechanism by which markets can not get out of control. Whether or not you agree with the ability to add Alpha, active manager discretion is a valuable part of stock investing.