Why It Pays to Be an (Informed) Active Investor

In today’s Money Morning…a glimpse at how wild and whacky markets have become…not everyone is cut out to be a trader…an explosion of passive investing…and more…

Cryptocurrencies, meme stocks, and short squeezes.

These are the trends that have dominated the investing narrative in 2021. A glimpse at how wild and whacky markets have become.

A possible precursor to some greater change or event.

Good or bad.

After all, the media loves talking about and critiquing these topics. Often citing them as the cause of the next big ‘bubble’. Despite the fact that half the time they haven’t even got a clue what they’re talking about…

One look at the headlines overnight from the US will tell you that much. With AMC Entertainment Holdings Inc [NYSE:AMC] the talk of the town. The latest flash in the pan investment, much like GameStop was earlier this year.

But I’ve already aired my thoughts and grievances surrounding the meme stock trend.

Instead, what I want to talk about today is the surge in a different type of investing. One that has attracted far less media attention but is just as compelling.

I’m talking about the rapidly increasing dominance of the ETF market.

Or, as many refer to it: passive investing…

Not everyone is cut out to be a trader

Now, let me start off by saying that I am not totally against exchange traded funds (ETFs). I do believe that they serve an important purpose.

After all, ETFs are a great way to introduce inexperienced investors to the stock market. Delivering relatively modest returns from a low-risk investment.

A far better alternative to many of the hedge fund pariahs out there in the world. Who, despite their egregious fees, often deliver worse results than your average ETF.

However, just because some active investors are terrible at their job, doesn’t mean all are. Because beyond the hedge fund managers and investment bankers of the world, there are some damn good traders. People who have developed proper strategies or systems to deliver market-beating returns.

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How do I know this?

Well, because I’m lucky enough to work alongside some of these expert traders myself…

Murray Dawes, for instance, is our resident trading guru at Money Morning. A market maestro with years of experience who has honed his trading methodology to perfection. So much so that we believe he could contend as one of the best traders in Australia.

And if you think that’s a far-fetched claim, well, I urge you to check out Murray’s recent demo. Showcasing how he delivers some of the most consistent returns to his readers.

The point I want to make, though, is that not every investor is going to be like Murray. Most of us don’t have the time or energy to devote to trading markets all day, every day. And if you can’t commit to that, then it is easy to justify parking your money in an ETF and letting compounding do its thing.

Which is exactly what people have been doing.

And not just ‘some’ people. A lot of people!

An explosion of passive investing

In Australia, ETFs are now worth a combined $100 billion.

Nearly doubling in total value from 12 months ago. Back when ETFs were worth just shy of $57 billion.

Granted, some of this growth can be attributed to the strong market returns of late. But the majority of it stems from a record number of investors piling into the passive investing boom.

As Business Insider reports:

While the bull market has helped, a Stockspot spokesperson told Business Insider Australia that only 30% of that increase could be attributed to market movements. The vast majority of the growth, or some $30 billion, has been new investment flowing into ETFs.

Which certainly isn’t surprising given the fact that plenty of people have discovered the stock market amidst this pandemic. With an estimated 430,000 Australians dipping their toes into equities for the first time last year.

And if the growth of ETFs is any indication, a lot of them are opting for the passive route.

According to the ABC, 1.3 million Australians now have money in some sort of ETF. Doubling the number of people recorded just two years ago.

Again, at face value, it’s great to see this kind of interest in equities grow. Because I am a firm believer that everyone should have the opportunity to grow their wealth through markets.

But at the same time, this passive investing boom is going to force us all to start asking certain questions. Because while the world has yet to really see an ETF crash so to speak, the amount of money pouring into them is troubling.

I’m certainly not the first to raise this issue, though. There has been plenty of discussion (for years now) about whether passive investing is a bubble.

ETFs have grown to the point that they can dramatically distort entire markets. With concerns about a potential liquidity crunch if everyone were to sell at the same time. Which in theory may sound unlikely but could be a very painful reality.

Remember, we’re talking about many inexperienced investors who have all just jumped into ETFs recently. If markets take a turn for the worst and people decide they want out, it could compound the selling pressure, causing a cascade of prices and, therefore, a broader market crash.

Which is why the weight of ETFs is somewhat worrisome. Especially when they’re so highly concentrated on large-caps.

And this is the key, at least in my view. Because while small-caps are still somewhat beholden to broader market moves, they are also much freer. Rarely the domain of hedge funds, ETFs, or even superannuation.

They are riskier, that’s for sure. But they also can deliver significant returns.

Because while passive investing is fine for now. The active investor — when they know what they’re doing — will always do better.

Regards,

Ryan Clarkson-Ledward Signature

Ryan Clarkson-Ledward,
Editor, Money Morning

PS: Our publication Money Morning is a fantastic place to start on your investment journey. We talk about the big trends driving the most innovative stocks on the ASX. Learn all about it here


Ryan Clarkson-Ledward is an Editor at Money Morning.

Ryan holds degrees in both communication and international business. He helps bring Money Morning readers the latest market updates, both locally and abroad. Ryan tackles all the issues investors need to know about that the mainstream media neglects.

Ryan is also the Editor of Australian Small-Cap Investigator, a stock tipping newsletter that hunts down promising small-cap stocks by dissecting the latest events affecting the world.

To find out more about the publications Ryan works on and how you can subscribe, please click on the corresponding link here:


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