Tesla chief Elon Musk and Ark Invest founder Cathie Wood touted the benefits of active portfolio management while taking aim at the rise of passive investing, with the duo arguing in a series of tweets that the passive trend has gone too far, leading to market distortions and weaker returns for investors.
Musk waded into the passive versus active debate when he wrote in a May 1 tweet: “There should be a shift back towards active investment. Passive has gone too far.”
Wood later shared Musk’s tweet, arguing that passive investment funds have prevented many investors from benefiting from the meteoric growth of some disruptive firms, like the 400-fold gain in Tesla stock.
The electric vehicle maker didn’t become included in the S&P 500 until around ten years after its IPO, after it had already hit a market value of around $650 billion.
When Tesla went public, it was worth around $1.6 billion, offering a lucrative entry point to prescient—or lucky—stock-pickers who are in the active camp.
“According to ARK Invest’s research, most broad-based passive funds are ‘short’ disruptive innovation at a time when the global economy is undergoing the largest technological transformation in history,” Wood said.
“In my view, history will deem the accelerated shift toward passive funds during the last 20 years as a massive misallocation of capital,” she added.
Passive investment funds, which basically track the performance of an underlying market or index on autopilot, lure investors with the promise of sharply lower costs than their actively managed alternatives.
Coupled with doubt about whether active portfolio managers can really deliver market-beating returns and so provide investors with the added value that justifies higher costs, there’s been a rise in the popularity of passive funds.
But there are drawbacks, with the typical argument being that since passive funds track a given market, they will underperform that market on average when management costs are factored in. Another common argument is that passive funds don’t provide investors with a hegde in the event that a given market dives.
Active stock pickers, on the hand, have the potential to carefully select assets with the potential to set up hedges and deliver market-beating gains.
That’s an argument Musk highlighted in a tweet: “Passive/index investment is simply an amplifier of active investment. If active investment signal degrades in quality, passive is proportionately impacted.”
“Also, if there are very few actual active investors, their decisions can greatly increase company valuation volatility,” he added.
The debate around passive vs. active investing has become more nuanced with the development of smarter strategies that try to incorporate sophisticated stock-picking arrangements into passive funds to boost returns or tweaking index construction.