Investing based on buying an index, popularized by exchange-traded funds, may be reaching “bubble” territory, said John Rogers, founder of the Ariel Fund.
He said active managers are feeling greater pressure to own what everyone else owns, so many managers are now “closet indexers.”
“We have all these ETFs. People are buying baskets of stock based on the fact they’re part of this basket,” he said during a recent investment gathering his company hosted n Chicago. “And I think it’s going to end the same way the internet bubble period ended, where people continue to buy stocks for reasons that have nothing to do with fundamentals, but based upon what index they get put into. Then you can get into some kind of outrageous valuations of companies that don’t make sense relative to the long-term growth rate or the strength of the business.
That doesn’t mean he’s completely against indexing as a whole, noting that research shows that about 80 percent of large-cap active managers in 10-year periods have underperformed the Standard & Poor’s 500 stock index.
“I think markets are extraordinarily efficient,” he noted. “After 30 years of doing this, I’m more convinced on the idea that there are very few active managers that can outperform is true,” he said, adding that it makes sense for many people to have a core of index investments with some satellite active products.
After spending decades in investing, Rogers and Mario Gabelli, chairman and chief executive officer of GAMCO Investors, say that investing trends come in waves, and the passive indexing is no different.
“I’ve been doing this for 50 years. I’ve seen a whole change in structure of the way people buy and sell stocks” Gabelli said. “There was the Nifty 50. The banks in ’71, ’72, ‘73 bought stocks they called the Nifty 50—buy a growth stock hold forever. So you had companies like International Harvester on the list. Companies like Avon, Polaroid so on, they went to 50 times earnings and [fell]. Some survived.
“What is the new mantra?” he asked. “Basically, you can’t beat the market, buy an ETF.”
He said ETFs will never be up in a down market, unlike an active manager who might outperform. But he sees ETFs as another investment tool.
“It’s another form of investing. I have absolutely no problem with them,” he said.