How far down the road have we already come?
Record weighting by the big stocks has caused a record World Index weighting by the US. Tick.
Record valuation differentials between large-cap growth and cheap smaller companies. Tick.
Diminished volatility as the VIX trends lower over the past few decades. Tick.
Companies, particularly the largest, tending to revert post-earnings shocks. Tick.
Once you make it big, you’re in the club. A great example is the way meme stocks have held up. Only after nearly three years has GameStop gone back down. It briefly became the largest company in the Russell 2000, issued evermore equity, and its biggest holders became passives.
Clearly we’re further down the road than we think. The answer for investors? Don’t try to fight the trend. The magnificent seven are not going anywhere soon. However, as their high valuations diminish their future expected returns, we still don’t want them.
The small and value sector, with low ratings not seen since the golden days of the 1970s – and much lower passive involvement – are expected to have better long-run returns because of their extreme cheapness.
The future will be to create better algorithms than the S&P 500, ones that better allocate capital. That is what investing is.
Smarter exchange-traded funds will incorporate predictive factors such as total shareholder yield, insider buying, high price/sales ratios or momentum. We already use these factors, and more, as we are mindful they are destined to be more important.
Algorithms to uncover intangible predictors, such as good management and trend anticipation, no doubt lie in the wonderful world of artificial intelligence, and have much to offer professional investors and their clients.
As passives use AI to try and predict more human qualities, and actives take on more quant strategies, the lines between the two styles of investing will become blurred.
We are thus led back to thoughtful allocation of capital, which is what active management has always tried to achieve.
Richard de Lisle is manager of VT de Lisle America fund
