What caught my eye this week.
There’s a mildly titanic battle going on in the beleaguered UK investment trust space.
Everything from the rise of index funds to the 2022 reset in interest rates to steady outflows from all UK equities – not to mention lousy performance in many cases – has left the sector littered with sub-scale funds trading on huge discounts to net assets.
Kicking the boot in were disclosure rules that made often high fees look ever higher. That prompted wealth managers to abandon the sector in fear of fiduciary regulation violations.
But it’s probably the unstoppable might of an S&P 500 tracker fund – or even just a global equities ETF – that has done the most damage.
Why own an old-fashioned investment vehicle with a board of directors and odd assets from all over the place when the simplest ETF has trampled your returns – and with less volatility for good measure?
No wonder even a bluest of the blue chips trust like RIT Capital Partners has traded for as much as 30%-off in recent times.
Or that I’ve been drawn like a moth to this bin fire for multiple Monevator Moguls articles – and with many more to come I’m sure.
My precious
Now if everything I just wrote made no sense to you then (a) congratulations, you’re hopefully a passive investor in cost-effective index funds and (b) you’re part of the problem, from the other perspective.
You see, investment trusts were the original collective vehicles, invented more than 100 years ago to enable everyday investors to get exposure to much wider pools of assets at a far lower cost.
They were the global trackers of their day. But the problem is that the global trackers of the day these days are, well, global trackers.
Even worse, attempts to recalibrate trusts towards more sophisticated investors by offering more exotic exposures have also come a-cropper.
In theory, investment trusts are the perfect vehicles to enable the ownership of more illiquid, unlisted, or esoteric assets, whether that be music royalties, wind farms, or warehouses for the logistics industry.
Investors don’t really need these in their portfolio, but a case can be made for all of them.
Yet they’re about as popular right now as a glass hammer in search of a nail. And as soon as their underlying assets face a problem – such as more competitive yields from government bonds – it seems investors dump these trusts. The discount widens and a potential death spiral begins.
So again, the dispassionate reading is these vehicles have outlived their usefulness. The market is telling us that.
As Brandon Lee said in The Crow: “They’re all dead. They just don’t know it yet.”
They have a cave troll
Well maybe, but I’m an investing romantic. Where you see a bunch of overpaid fund houses peddling unwanted products to a disinterested market that’s moved on, I hear J.R.R. Tolkien.
One phrase keeps coming to mind from The Lord of the Rings. The ‘last alliance of elves and men’ that united to defeat the dark Lord Sauron, who in Tolkien’s mythology represents brutish and ugly modernity.
And conveniently, in the last year or so we’ve been able to put a face on this fanciful clash. One Mr Boaz Weinstein of Saba Capital, an American hedge fund manager turned supervillain in the UK Investment Trust Cinematic Universe for his attempts to roll-up and extinguish seven of their number.
Weinstein is – conveniently for scriptwriters – a brash American, who dubbed his targets The Miserable Seven amongst much else. It’s fair to say both the press and the trust industry returned fire in kind.
Critics point out that Weinstein can see what many of us can see – that trusts trading at big discounts to their net assets are pregnant with value – only he wants to unlock it more for himself and his wider business aims.
Ironically, such discounted value has always been underwritten in investment trust lore by the potential of an activist to come along and liquidate a fund to release it, even if the possibility might often have seemed more theoretical than red in tooth and claw.
Yet now that Weinstein has set about doing it at scale, it’s a different story.
To quote another suitably-geriatric screen legend: “They don’t like it up them Mr Mainwaring.”
All that is gold does not glitter
I see and acknowledge everything above.
But as I said, unlike my purely passive co-blogger The Accumulator I’m an investing romantic.
And so I mentally punched the air this week when the first of these seven battles was resolved – with shareholders voting overwhelmingly to reject Saba’s takeover of the Herald Investment Trust.
A whopping 65% votes went against the hedge fund manager. Exclude Saba’s own 35% stake and just 0.15% of shareholders sided with the enemy at the gates.
A last alliance of fund managers and ordinary investors indeed. Hargreaves Lansdown – which, like other platforms, has publicised and facilitated the votes – said such engagement was ‘unprecedented’.
This, my friends, is the shareholder democracy that some say is being destroyed by passive investing. Active funds that (ideally) strive to allocate money towards the best prospects, and engaged shareholders who (you’d hope) care how and where their money is invested and managed.
Even the very wise cannot see all ends
Of course the Monevator house view is that most of us shouldn’t bother with any of this active malarkey.
That’s because index funds can more cheaply hitchhike on the price-discovery efforts of active managers – or parasitically exploit them, if you prefer – and active investing is a zero sum game.
The result is the average investing pound will do better in an index fund than in an active fund. Any big picture consequences are moot when it comes to growing your own wealth.
As for engaged shareholders, long-time readers may recall the research that claimed it was the investors who checked their portfolios the least who saw the biggest gains – with the actually-dead doing best of all.
This house view hasn’t changed. I’m having fun on Moguls with some like-minded souls, but as our motto says Moguls is not for everyone. Me and TA overwhelmingly believe that until proven otherwise, passive investing will be the best approach for the vast majority of individuals. There may eventually be issues if everyone invests passively, but game theory says until then do what’s best for you.
And so this resistance to the supposed barbarian at the gate of the trust realm may really be a last alliance. A generation of likely older fuddy-duddies getting uppity about someone coming for their trusts – before the sector is flattened anyway by the inevitable victory of ETFs and index trackers.
Why fight it? They’re all doomed.
Well, maybe. But I’m an investing romantic and I was rooting for Gandalf and the gang outside the gates of Mordor. There’s room for everyone, and I’d miss these trusts were they to disappear.
One battle down. Six to go!
Have a great weekend.
From Monevator
Our updated guide to help you find the best online broker – Monevator
FIRE-side chat: better late than never – Monevator
From the archive-ator: Another good reason to open an ISA – Monevator
News
Note: Some links are Google search results – in PC/desktop view click through to read the article. Try privacy/incognito mode to avoid cookies. Consider subscribing to sites you visit a lot.
British firms cutting jobs at fastest rate since 2009 – Proactive Investors
UK borrowing unexpectedly jumps – BBC
Cracks showing in Britain’s reserve currency status – Reuters
Rachel Reeves backs looser limits on mortgage lending [Search result] – FT
Hedge funds kept $1.8 trillion as fees; half their gains – Bloomberg via Y.F.
New rights for UK renters could come into force this spring – Which
Shein backlash fails to deter shoppers – BBC
Santander considers UK exit amid frustrations with high street banking – CNBC
Back to the office helps City of London’s tallest tower to full capacity – City AM
GMO’s new return forecast includes estimates if real rates contract – GMO
Products and services
Gilts turmoil pushes up annuity rates to almost 7.5% – This Is Money
TSB bank switch offer: up to £160 + £30 & NOW TV – Be Clever With Your Cash
Get up to £1,500 cashback when you transfer your cash and/or investments through this link. Terms apply – Charles Stanley
Does your insurance cover damage caused by bad weather? – Which
How to buy leasehold and avoid ‘fleecehold’ [Search result] – FT
Spike in borrowers in their 30s taking on ultra-long mortgages – This Is Money
Get up to £4,000 when you transfer your ISA to InvestEngine our link. (Minimum deposit of £100, other T&Cs apply. Capital at risk) – InvestEngine
Barclays the latest lender to bump up mortgage rates – This Is Money
Our friends electric, and gas – Getting Minted
Homes for sale for doer-uppers, in pictures – Guardian
Comment and opinion
The stock market is both a voting and a weighing machine – Morningstar
Is there a problem with passive investing? – Of Dollars and Data
Active ETFs are an extremely clever wheeze – FT
Investing is hard – Behavioural Investment
Gen Z Americans leaving European cousins in the dust [Search result] – FT
The devolution of US public capital markets – Cullen Roche
Money grows up – Humble Dollar
Time to lock-in 5% bond yields? [US but relevant] – A.W.O.C.S.
Estimating the probability of dementia – Oblivious Investor
“FIRE first, then a house” – Strong Money
Are you resilient? – Can I Retire Yet
Jonathan Clements on indexing, investment writing, and death [Podcast] – M.I.B. via Apple
Naughty corner: Active antics
Investors lose their appetite for the obesity trade – FT
Three reasons to buy bonds [US but relevant] – Animal Spirits via Apple
VC-backed unicorns still waiting for the exit lane to open – Institutional Investor
Forecasting returns for 2025 for the UK stock market – UK Dividend Stocks
14% a year? The cost of being entertained by thematic funds – Morningstar
Trump and the return to an inflationary era – The Bonddad
The state of the video games industry in 2025 [Slides] – Matthew Ball
Rather rich mini-special
More than 10,000 millionaires have left UK, says one analyst – Standard
Britain to soften non-dom tax rule changes following exodus – CNBC
Wealth of world’s billionaires grew by $2tn in 2024, report finds – Guardian
The persistence of elite wealth in American history [Research] – NBER
Reeves is alienating wealthy entrepreneurs who bring jobs – Independent
Kindle book bargains
Saving Time by Jenny Odell – £0.99 on Kindle
The Black Swan by Nassim Taleb – £0.99 on Kindle
Good With Money by Emma Edwards – £0.99 on Kindle
Number Go Up: Inside Crypto… by Zeke Faux – £0.99 on Kindle
Environmental factors
The impact of renewable energy on electricity costs – Klement on Investing
Great Barrier Reef hit by most widespread bleaching event ever – Guardian
Trump halts $300bn in US green infrastructure spending [Search result] – FT
Toads on the roads – Biographic
Crypto o’ crypto mini-special
The madcap rise of memecoin factory pump.fun – Wired
Your memecoin is your slush fund – Noahpinion
Trumpcoin and TikTok – Kyla Scanlon
Robot overlord roundup
Try China’s DeepSeek, which may be smarter than OpenAI’s AI – Mashable
Tips on using AI in your own work – Darius Foroux
Announcing the Stargate Project – OpenAI [and bashing it]
How we can use AI to create a better society – FT
Anthropic CEO sees a ‘country of geniuses in a data centre’ – Business Insider
How GenAI is coming for [what’s left of] media [Slides] – Doug Shapiro
AI’s latest model will change economics of software [Paywall] – Economist
The living isn’t easy mini-special
If you want to live a quiet life, live a quiet life – Susan Cain
The ‘masculinity crisis’ is actually a crisis of self-esteem – Psyche
Oliver Burkeman on the imperfect life – Behavioural Scientist
Off our beat
California Dreaming – Scott Sumner [h/t Abnormal Returns]
Which music was under-appreciated in its time? – Stat Significant
Elon Musk has been paying to level-up his video game characters – Futurism
The best time to eat dinner, according to longevity experts – GQ
“It could be Marvel”: Games Workshop and its big ambitions – BBC
Long-term bullish on the Middle East – Noapinion
Principles – Nabeel S. Qureshi
On fleeing the inferno – More To That
And finally…
“Look at your cash everyday if you wish, your bonds every couple of years, and your equities every ten years! Really, do not look at your performance more than once a year.”
– Tim Hale, Smarter Investing
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It does seem strange that you can buy a product at a discount but cant realise it!!
unless your name is Boaz.
Probably obvious thing to say, but I take these ITs one by one. Some deserve to survive, while arguably the BG ones could do with a shake-up, as I was more for the older BG Profitable Growth strategy, not so much Flying Taxis. Though I’m not sure I’ve been convinced by what the Alternative is – it’s not like we’re spoilt for Active Managers in the UK, and Saba don’t really seem to have a record.
TBH, given my knowledge of fund houses, I wouldn’t mind a bit of transatlantic collaboration here. 1) There are some great US Active Managers 2) There are very few US-focused Investment Trusts. See where I’m heading…
My dream would be for Investment Trusts managed by the likes of KAR, Vulcan Value, Akre and Granahan. Heading back home, a Findlay Park IT wouldn’t be sniffed at (though admittedly like everyone else they haven’t outperformed their index for a while).
Realistically there aren’t going to be many new ITs – a) who wants to buy at NAV when it’ll shortly drop to a discount and b) maybe it’s a bit better now, but if even the fairly well-known Buffettology couldn’t get support for an IT, what hope would little-known US boutiques stand? But if current ITs got replaced, maybe it would work?
I always loved the idea of ITs, but I do think that currently part of the reason for the hefty discounts is that most of the current Fund Managers just aren’t very impressive. I know there are reasons why (regulations make it harder for new boutiques to start), but it feels like the previous generation of ‘stars’ like Simon Knott, Harry Nimmo etc. have not been replaced.
@Tom_Grlla — Ah, Simon Knott, now there was an eclectic manager with a stellar record who did his own clearly alpha-generating thing.
I once messaged William Green of Richer, Wiser, Happier fame suggesting he seek Knott out after he retired, and provided Green with a record of Knott’s returns.
Green apparently saw the message but didn’t even acknowledge it. I’m sure he’s busy and gets a lot of messages, but given the big game he talks about staying humble and grounded — and that there was nothing in it for me anyway — I must confess to being a bit disappointed not to even get a thumbs-up emoji back! 😐
I had great fun with investment trusts in my long evolutionary pathway to some form of financial literacy
They were my second investment step after insurance companies (Equitable Life anyone?) and U.K. funds -M&G etc
Personal Assets Trust was a such a fund of great information via Robin Angus’s erudite essays .Ian Rutherford was obviously a star manager/investor
Their particular conservative investment stance appealed greatly to to me
Alliance Trust was the instigator of my original SIPP with a clunky but workable platform-trailblazing
But……..they were obviously so dependant on individuals many who sadly are no longer with us-performance often suffered accordingly
They cost more and when Index Tracker funds appeared-F&C,Witan,Alliance Trust were obviously just expensive closet index trackers
That was it for me -that was many years ago
I do miss the characters ,the writings -the possible putting of “lipstick on a pig” but in a very human manner -we all want to be better and more successful investors than the next guy……
xxd09
“There may eventually be issues if everyone invests passively, but game theory says until then do what’s best for you.”
Disagree. The effective level of index-investing is so much higher than the headline level. Way before 100%, we’ll start to see major issues. I think we can already see those issues now appearing. Extreme momentum effects, low market resilience masked by high transactional liquidity, increasing inelasticity etc. Inefficiency is rising and have to wonder if some of these NAV discounts (only some) are a function of that increased inefficiency.
“UK to soften tax rules for wealthy foreigners”. I have never seen in 28 years in the City, both foreign and domestic workers leave at a higher rate. My office will be empty soon. Geneva, Singapore, Abu Dubai, New York are destinations. Even when income tax was 50%, people didn’t leave at this rate. Feels like the tax revenue base could collapse.
“The ‘masculinity crisis’ is … a crisis of self-esteem”. Honestly, what a pile of crap. What masculinity crisis? Males still hold too many advantages.
Thanks for the links. Always thought-provoking.
I think we’re living through an interesting period of British financial and social history and it’s continuing decline – the episode with Saba (which is very interesting and I’m glad you noted it) is an example which would have been inconceivable 20 or even 10 years ago.
I have been watching RIT with great interest as a barometer over the past few years, despite having no stake. If the legendary Rothschilds can get it so wrong (and bleet in articles they are not), what chance do mere mortals have? Saba rightly smells blood.
While we as an island nation naturally like to think of ourselves holding off the hordes – even Tolkien style – the reality is they’ll be back next time in greater numbers. Because fundamentally Britain is weak. Weak against the dollar and the world – not just the S&P – and has no real plan – or maybe even ability – to reverse that. I’m not going to blame the government or Brexit for that (although neither help) because the causes are complex – maybe some was even unavoidable. We are seeing all these consequences play out now and for the foreseeable future.
Let’s hope that future is a better place!
@ZXSpectrum48k Regarding index funds, have you altered your investment strategy in response to this problem? What can the average passive DIY retail investor do to shield themselves from the potential fallout?
Thanks @TI for great links. Particularly enjoyed music under-appreciated in its time, even with a US slant. Unpopular music: one of few remaining ‘markets’ in which a home bias adds value!
@2my (#8):
I liked that article too – but surely it is utter nonsense that the Smiths (and I guess to a lesser extent the Pixies) were under-appreciated [in the UK] in their time – or is this what you meant by US slant/bias?
@TI, shout out for including my suggested link to ‘FIRE first and then a house’. I loved the post because it’s about ‘throwing out the conventional rule book and intentionally designing a life to prioritise happiness first, while simultaneously still building wealth in the background’.
I hope it resonates with UK readers! Look at our beaches … 🙂
@Al Cam – so agree (esp Pixies, who I was privileged to see at Reading, think it was 1990) Lots of great music from the States, both of its, and standing the test of, time. Ditto UK where (just meant that) we have historically and continue to punch above our weight. Article mentions Nick Drake but numerous others. Might have to ‘fire’ up the vinyl this evening!
@2my (#11):
Re: Might have to ‘fire’ up the vinyl this evening!
Or try this, if you have an hour to spare: https://www.dailymotion.com/video/x8ovcu2
As someone who follows a bit of everything approach, I hope investment trusts are here to stay. Would say my strategy is passive plus (VGLS80, with a side of core investment trusts based on MoneyWeeks investment trust portfolio). Aiming for a 70/30 split towards passive, for no major reason other than the weight of the mag 7 concerns me and I feel having a bit of active covers the small cap and private equity space missing in the passive space. But who knows, really.
I don’t think any of the trusts I hold have Saba as shareholders. But ultimately I think its a big wake up call for the sector, in terms of engagement of retail investors, shareholder voting and communication from the boards of trusts, which is generally fairly woeful. ii are pretty good at highlighting the AGMs and stuff, seems like other platforms are following suit.
Big shout out to the Susan Cain piece. Her book on introverts was genuinely life changing for me (see also, this site for money 😉 ) in understanding my personality type and acceptance that I don’t need to chase shiny things or pretend to be something I’m not.
Have a good weekend all.
Cheers for another cracking set of links.
Good article. Agree with your sentiments on Investment Trusts. However…Few years ago as a long standing holder of Alliance Trust I was appalled when they had a rush of blood to the head and went for a radical revamp including appointing a wonder child from that well known cost efficient powerhouse Norwich Union. I got personal letters from the Chairman and CFO or equivalent on what looked like a hand typed letters. This exemplifies the human touch of the Investment Trust world as of then, and also it’s archaic practices. Reckon I was right though about their changes ( I sold out). However, I still don’t like the machine characteristics of passive vehicles and prefer IT’S.
Looking at the links, is GBP still a ‘reserve’ currency ?! Maybe I’ve been unduly down on the poor thing but that surprised me.
Finally, as I now have your no doubt divided attention, any chance for a follow-up article on structured products ( perhaps as an alternative to annuities) ? :).
Anyway thanks for the article, cheers.
Yes, I was glad to see Susan Cain up there. A work friend recommended her book to me. I was already happy with my identity as an introvert but, even so, after listening to the first chapter of her book I felt so much better about myself and very validated.
My friend thinks everyone in a management position should be forced to read it – so much strife at work seems to be a consequence of extroverts not understanding the introverts.
Started investing in Inv Trusts in the 1980s switched to passive ETFs when they became available. I can’t imagine why investors would invest in Inv Trusts now ,maybe if you want active management in some areas. It’s a sector that did serve a purpose but going forward there are cheaper and easier ways to invest
1st para @ZX #5: having flagged Mike Green (of Thiel’s spectacularly successful Feb 2018 Volmageddon trade) several times in the comments recently, not surprisingly I agree with your observations.
Whilst I’m not quite a full fledged ‘card carrying’ member of the Inelastic Market Hypothesis’ school, it looks to me as though something is probably up.
In any event, I am surprised that no-one yet (at least whom I’ve read so far) in the finance ‘blogosphere’ engages with the detail of some of the main arguments underpinning the IMH, especially those leading to the conclusion that passive flows have higher persisting price impact (per $/per unit time) than active, both for mathematical and structural reasons.
This incuriosity on the details of IMH by the blogosphere is the case even for really excellent, well written, considered and balanced PF / investing writers like Of Dollars & Data and AWOCS.
There’s much more to the IMH arguments than just that passive will cause price discovery to fail at some point.
My own thoughts presently for how to adapt are tending towards a barbell of a few maximally risky, high momentum, high index cap weight stocks in an under weight equity sleeve and the rest in an overweight of long bonds (de/disinflation risk), commodities (in/reflation risk), gold (uncertainty hedge), trend and listed global macro HF. This looks nothing like my nearly all equity global tracker led portfolio at the moment 🙁
#10 @London a long time ago, good link – surprised and delighted to read about someone doing a house truck in this century. The very early years of my life were spent living in one, my parents having taken that route in their 30s!
I keep watching ITs and the process usually goes: Oh, nice discount. Great it’s been beating its benchmark over 5 and 10 years. Let’s look at mandate and portfolio. Hm, looks very much like a xyz (e.g. value) play. Let’s chart against MSCI xyz. Wow – a bit of underperformance – likely due to the discount but pretty much spot on. Do I really want to invest in xyz and if so why not use xyz ETF at a fraction of the cost?
As another of those grateful for Investments Trusts and the gains I made in the 90’s and naughties, things have changed and the specialist trusts may prosper but the generalists will struggle against passive funds unless…..
The S&P500 has had a splendid run and the concentration in a small number of stocks makes anything else almost a guarantee of underperformance.
I share ZX’s concerns about passive funds impact, both those indexing and those influenced by indexing but do not have the insight to see when(if) anything happens.
The almost universal acceptance of the only place to invest is in the US and then to concentrate in a handful of “obviously great winning companies” leads me to consider what if’s and select bonds etc to counter possible scenarios plus ensuring the ability to finance 15+ years without having to rely on my equity holdings.
Sometimes it’s time to stop reading other people’s ideas and sit quietly and think independently for an extended period , block out the noise, it’s certainly helped me in the past.
Thanks for the interesting comments and feedback everyone. I’ll just make a couple of quick general comments.
On investment trusts, I think one can separate pondering the future of them as investment vehicles from ‘are there opportunities at the moment’. I don’t think there’s strong evidence that anyone needs any of the global tracker-y style trusts versus a cheap tracker (though seem comments on passive distortions to come below, I suppose) but one might prefer to own it until the general revulsion at the sector / outflows / non-Mag 7 passes. If the latter then something like BNKR could see its own NAV rise ahead of a global tracker, plus the 10%+ discount narrow to par, delivering worthwhile outperformance, while from here it hopefully shouldn’t deviate too much further to the downside, at least over a shorter timeframe, so might be a tad safer than say VRWL.
As I used to stress in the old days of infrastructure and renewable trusts trading at 20% to 30% premiums etc when they were raised in these comments, the time I personally am nervous about trusts is when the market is coming up for reasons for why they should be worth so much more than what they own.
Of course at such times there’s a rationale put forward, and I don’t mind 1-5% say for a trust knocking it out of the park, but long story short I’m much happier buying a trust at a 20% than a 20% premium, unless there are idiosyncratic reasons for that trust in particular trading at a discount. (Even so, you might say own Hansa trust accepting it’ll never see the discount close because of a large family holding, but want to own it for portfolio specific return reasons).
People always wonder about how discounts will close but they generally do, at least for a spell. We’ve even seen it with several of the Baillie Gifford funds in just the past 18 months, albeit it’s unclear how much of that was driving by this specific activist activity!
Bottom line, I still think if you’re an active and perhaps nimble investor there must be easier opportunities here, versus trying to judge whether Oracle is going to do better than Arista Networks or Tesco versus M&S, say.
The trust sector is so unloved. And we’re also increasingly seeing liquidations / other exit opportunities at NAV now facilitated by the trusts themselves, which takes an element of waiting for Godot out of the equation!
On passive flows disrupting the market, well most of this is far above my pay grade, which is why I basically go with the expert consensus while still linking to the best of the counter-arguments as food for thought for myself and others. 🙂
Compared to saying ‘passive has broken the market’ I do find it much easier to believe/agree that passive flows could be distorting short-term prices and creating thinner and more vulnerable markets that seem less volatile until they don’t, hit an air pocket, and recalibrate more violently than they would in a more heterogeneously populated system.
That seems plausible, and would broadly fit with what we’ve seen from market behaviour in recent years.
The bigger question of ‘at what level of passive investing do markets break’ I think is more talking about long-term and enduring dysfunctionality, rather short-term turbulence / new pricing regimes? At least that’s how I read academics say stuff like ‘don’t worry until we hit 90%’. But I could be wrong about that.
The market still seems broadly to be behaving like Ben Graham’s weighing machine over the long term even if it’s a more febrile voting machine over the short-term. Growing market caps do seem to broadly be tracking growing earnings still. That needs to break I think for passive investing to truly have ‘broken’ the market, but I’m out of my depth academically with this and again this is different from short-term price moves, thin markets, vulnerable (/inelastic) markets etc.
The other question is what do we do about it?
Let’s say passive flows have pumped lots of money into US markets and increasingly to the largest companies, and that this is somehow distinct from previous periods of excessively exuberant flows and valuations.
Evidentially it’s not easy to trade against it. It’s probably no accident we don’t hear much about star fund managers these days, that all the old ‘quality’ guys are under the cosh, and that the likes of David Einhorn say there’s no price re-discovery taking place in the market any more. Of course they could be individually hot hands turned cold, but this does seem to be the broad swathe of opinion, and it fits both my own experience and what I’ve seen of the mass of even skillful-seeming private investors in recent years too.
Which is all to say that betting against US large cap tech has been a widow-maker for years, depending on how big your underweight and to what extent whatever else you bought was able to make up the difference.
We could just say ‘be more diversified than usual’ and indeed we have hinted that way. But for example I had a reader write to me to tell me they unsubscribed because of this article:
https://monevator.com/what-to-do-if-youre-queasy-about-the-us-stock-market-members/
That article was (I hope) pretty humble and appropriately full of caveats given the trend and the uncertainty of valuation based forecasting etc, but I still got the “so what do you know” treatment afterwards, from at least one person.
It reminds me a bit of near-zero yields on bonds. We first began warning about that in perhaps 2010! For at least a decade paying any attention to such warnings was a losing trade, versus just going with the market momentum. Yet *after* the correction, ‘everyone’ now seems vehemently against bonds of any duration, etc.
With my own money I’m very underweight the US and especially US large cap, though most of what US stuff I do own is technology so perhaps I’m just getting effectively the same risk exposures by the back door.
I don’t know. I feel very humble about it all to be honest.
Clearly something is up with AI — the newest models already feel very different from just 18 months ago — and perhaps this time the market has correctly sniffed out that it’s different.
Or perhaps it’s just the usual over-extrapolation, at least in the short-term, and eventually mean reversion will win out and those of us who’ve continued to own other stuff, or to trade more opportunistically for some our gains (see investment trust post above) will be vindicated.
Time will tell, but I wouldn’t be surprised by either outcome at all.
@Wodger. Think a hypothetical example. An index fund who has consistent inflows need to replicate the index return subject to a defined error margin (the tracking error). So, the index fund doesn’t need to buy the whole index to replicate efficiently. There is no need to buy the small companies as they contribute little to tracking error, just a target set of large ones since they generate a vast proportion of the return.
So, every inflow is invested more in the target large cap stocks than the rest, relative to their AUM. Because of that, the target large cap prices rise relative to the rest. Which makes their AUM a relatively larger part of the index. This causes the fund’s tracking error to fall. So, the fund can now sell a bit more of the rest to buy the target large caps to rebalance the tracking error back up. Which pushes the large cap price up a bit further up relative to the small caps. A positive feedback loop now exists.
The magnitude of the loop is small if index investing is small relative to active investing, but as index investing gets larger, the feedback loop becomes more pronounced. Another positive feedback loop. The fundamental driver of that feedback loop is inflows. If the fund experienced outflows, the whole process would go into reverse.
Moreover, since inflows are typically a function of lagging returns, the more the large cap outperform, the more inflows they get and the less the rest get. Another feedback loop. Increasing outperformance even more.
If the market isn’t perfectly elastic (which is cannot be), then these feedback loops can actually drive prices much higher for the target large caps. The effective leverage can be 10:1 as the strength of the loop increases.
So based on this (very naïve) hypothetical model, large caps should outperform small caps if a) there are inflows and b) the ratio of index-investing is rising relative to active investing. The level of outperformance should accelerate as the relative AUM becomes more disproportionate.
If this sounds like I think we are in some sort of bubble, then, yes, I think we probably are. Generally, though you should go with a bubble, not go against it, since you just don’t know when it will pop. Now I don’t do stock picking. In equities I just buy trackers. It should be no surprise though I don’t own any small cap trackers or total market trackers. I tend to own the “core index” trackers which focus on a small subset of large cap companies. I also own tech trackers that focus on big tech companies. So, I am tilting toward this effect.
I would emphasise that this is only one driver of equity performance. There are many other equally or more important factors. Fundamentals (the US economy is absolutely killing other developed economies, especially in tech) and the Fed put (due to massive wealth effects from equity prices, US economic growth is now in a positive feedback loop with higher equity prices, so the Fed must cut if equity markets fall).
1770s: Finance, 1850s: Transport, 1920s: Energy, 1980s: Information Technology, 2030s: AGI?
Is the market overvalued (and set to underdeliver on returns)? And are passive flows ‘to blame’ (and to what extent if so)? Or it it animal spirits? Noone will be able to say even after the event yet alone now beforehand.
More useful to ask are, how can one prepare for different outcomes? What is the credible range of those outcomes? Can any plausible guesses as to approximate probabilities on that range be made? What vehicles are available to express that preparedness? How should one use them? Risks exist to the up and to the down sides (missing out v avoiding the big loss).
At the moment the *problem* with a cap weighted developed market global equity tracker (which I’m laden to the teeth with, hence the anxiety) is that it *might* (or might not) turn out to deliver the returns one needs but it can’t mathematically be said to be globally diversified with 68%-74% in the US (as @ermine memorably puts it “World In Name Only”) or diversified across even the large caps with 28%-29% in just 10 holdings (the top 10 in the S&P500 making up 40% of the index – so 0.4x(0.68 to 0.74) of the overall).
Personally, although I am now somewhat overweight EM and non-US SCV (both European and EM SCV), I can’t presently see non-US equities likely to do anything than fall too if the US large caps indices like the S&P 500 and the Russell 1000 tank, albeit that I still very much hope that they’ll then out-underperform those.
Non-equity assets like long duration high quality sovereign bonds might hopefully provide some welcome negative correlation but it’s difficult (to put it very mildly) to say if the threat of a sharp US equity fall would be more likely to be a deflationary event or one occuring against a backdrop of rising rates and high inflation (which might favour commodities).
For a balanced view of the current investment trusts sector, I recommend The Investment Trusts Handbook 2025.
Its arrival as a present every Christmas sets in motion my annual review of my fully Isa’ed, income generating, IT holdings; would I or would I not be better placed if I were to take out an annuity instead?
With my life’s raison d’être continuing to be that I shall leave the largest possible inheritance equally to each of my four adult offspring, I’m pleased to say that the ITs have carried the day yet again.
Much like xxd09 my first experience of investing was with ITs, their savings schemes were very low cost, usually only charging to sell, and you could invest low monthly minimum amounts. University expenses for my children were largely covered by holding SMT in the BG savings scheme, and my first SIPP was with Alliance. I too liked the approach of the Scottish trusts, in particular the PNL quarterly updates by Robin Angus were always a great read. I have a few IT holdings in my SIPP which for probably sentimental reasons I’ll hang on to for now.
Addendum and coda to @ZX’s #23’s important identification of two self reinforcing feedback loops above: additionally, although absolute liquidity is superficially greater for mega caps, per each unit of their enormous market caps it may actually be functionally smaller as market makers earn such a small spread (basis points) for the biggest names that they may have less incentive to hold as many shares as inventory relative to the total outstanding for those very largest firms. This can lead to a greater price impact from the relentless net buy of passive flows to index trackers from automatic monthly contributions: e.g.:
See comment here:
https://monevator.com/weekend-reading-tracking-your-trackers/#comment-1829822
And links summarised here:
https://monevator.com/passive-investing-edge-and-market-efficiency-winners-need-losers/#comment-1836533
Thanks to @TI, @ZX and @DH for your thoughts on index tracker market distortions!
Interesting that @ZX is taking the opposite approach to @TI and @DH — leaning into the bubble/tech overvaluation rather than attempting to diversify away from it. I wonder if an investor’s pattern of contributions and/or withdrawals affects this decision, as well as whether they intend to buy and hold equities through thick and thin or are prepared to tactically shift between asset classes in response to/in anticipation of a crash?
E.g., suppose you’re an accumulator who plans to keep making monthly additions regardless of market peaks or troughs. It seems to me that spectacular paper gains in over-valued tech stocks won’t do you much good over the long run if those gains evaporate after a crash — they just mean you over-paid during the run-up, ending up with fewer units of your index fund. But if you diversified into sectors that were priced fairly, and gains were driven by actual profits, then these gains could actually compound (unlike artificially inflated valuations) and therefore not evaporate over the longer term. Does that make sense?
@wodger — It’s always better to go with momentum while you can. I think it was Soros who said when he finds a bubble he invests in it!
Momentum is even a ‘return factor’ with academic bona fides.
The trouble with momentum is when it reverses it’s typically really brutal. That’s neither a fatal bug nor (obviously) an attractive feature, it is something a momentum strategy has to contend with. The flipside of say a value strategy where the risk is you sit in dead money for years waiting for some kind of mean reversion (assuming you are able to correctly identify ‘value’ in the first place).
Each to their own, there’s many ways to invest. 🙂
Just to clarify, currently just over 50% allocated to US core large cap, mostly via Xtrackers S&P 500 Swap UCITS ETF (XSPX) and, to a much lesser extent (although it could perhaps be a better product overall), the WisdomTree US Efficient Core UCITS ETF Acc (WTEF).
However, I’d quite like now to start to diversify properly into (alongside fewer equities) long duration government bonds, commodities, gold, trend following and BHMG, given the potential risks.
At the moment I’m not really leaning away from tracking the US; but I’m far too equity centric for my age (nearly fifty) and the gap between US and non-US, large and small, and developed and emerging market firms is getting towards historic extremes.
I do think that there may be (to a growing extent) some sort of a systematic ‘flaw’, passive flow-led, feedback loop driving equity valuations higher, but I want to move more towards positioning both to continue to try and take some advantage of that and also – unlike now – to try to cushion against the risk/ likelihood/ eventual certainty of momentum reversal.
@TI — Fair enough! Running towards a bubble just seems counterintuitive to me.
@Wodger — I agree by temperament, and as you noted it’s not what I’ve been doing recently.
I’m just saying it’s a legitimate strategy and for solidly legitimate reasons. 🙂
@Wodger
In my opinion, (for what little it may be worth), I think you and TI are both right in your own way.
As you mentioned, for a long term investor (who doesn’t need to redeem their investments in a hurry) the primary concern is the ‘final’ overall return so it doesn’t matter if in the short or medium-term there are huge gains, if there is a catatrophic loss at the end which makes the overall returns worse than you could have got elsewhere.
However, it is very, very hard to figure out when a suspected bubble is going to burst, and market timing ends up badly for 90%+ of investors, even professionals.
That having been said, I am more in cash now than every before and just today was thinking of getting long-term UK Index-linked Gilts. So I am guilty of the very thing I am preaching against.
@Wodger: I took on board two ideas sparked by remarks from ZXSpectrum. The first was the idea that one might have similar risk in bonds by holding 2 units of a 10 duration bond or 1 unit each of cash and a 20 duration bond. This is probably a gross oversimplification.
The next was the idea of following rather than fearing equity bubbles. This worked for me as I am in decumulation and can park some of the excess profit in cash as it rises. I can either spend the cash – there’s quite a bit after the last couple of years – or bung some back in when the bubble properly bursts. It feels like a win whatever the market delivers. It’s not mathematically optimal but it feels fine.
@Onedrew:
I note you are in de-accumulation. OOI, how long is it since you pulled the plug and is that sufficient time to allow you to have developed a good idea of your actual spending as a retiree? Have you considered purchasing an index linked annuity to lock in some of your market gains over the last few years? RPI linked annuities at rates of >4% are currently available – depending on your age, options selected, etc. Just a thought.
Looks like the Mag 7 will be taking a little tumble today, as a consequence of news of China’s development of a LLM (according to the FT today).
@Al Cam: I stopped work, apart from an occasional visit to the office, in 2010 and received half-pay until fully retiring in late 2013. I bought an annuity just before George Osborne moved the playing field. I went 50/50 flat/RPI, steering my usual middle course.
I had enough cash to see me through to pension age in 2018 when a couple of pensions chopped in alongside state pension. I have always logged my spending and knew exactly how to cut costs to get by if we had to. In the event the global stock market’s delivery of new highs, some spectacular, every single year meant we have not had to be particularly careful.
I had been planning my retirement since I started work so I was oven-ready when the time came. My partner, whose job disappeared in 2020, was not ready at all but she is getting used to the idea.
Apart from the pension income we now have our investing bucket in ISAs and SIPPs and our spending bucket, mainly ISA-ed. When the investing bucket is larger than the spending bucket, we park half the profits. When eventually the position reverses we will only park a third until the spending pot is topped up. There would have to be a proper crash – 40% – before we would reverse the flow, but we certainly would. It would be too good an opportunity to miss.
@Alex — Yep, it’s DeepSeek, linked I linked to an article about in Robot overlord roundup above. It’s supposedly 50-times faster at some parts of the training pipeline, but I think it’s fair to say as usual there’s a lot of controversy and opacity around it / what it all means.
@Onedrew:
Thanks for the additional details.
Looks like you are well set.
Couple of Q’s if I may:
a) will recent IHT changes change your view of SIPP’s;
b) I get the point about reversal etc, but IIRC the “usual” measure of a bear is >20% off, any particular reason(s) for selecting 40% as this might mean you could miss out
@TI Big up the Simon Knott Fan Club! I went to a couple of the AGMs given the lack of commentary otherwise.
Only other thing I can think to add about ITs right now is that while I think they’ll make some money out of activism etc. I fear that CGT won’t make the killing they would have done 10 years ago, as they are just too big now for small ITs to be a substantial part of the portfolio anymore. I may be wrong.
@Al Cam: I don’t have a Sipp, but my partner has and is gradually moving it to ISA. I have not paid any attention to the IHT angle. I hope one of us gets to spend the lot! More seriously, I have only tax-optimised in the simplest of ways. I have started the youngsters with gifts to start them on the investment trail, 100% VHVG.
Re bear markets: one fifth of the investment bucket is there to buy on the dips on a series of rungs down to 35%. I would only want to risk the spending bucket for a really solid opportunity which for me starts at 40% and probably ends at 80% as a nod/wink to Pareto. I would not go all-in on this and expect there would be more important things to worry about by that stage.
@Onedrew:
Thanks for additional details.
Re bear markets: FWIW I have a similar plan in mind and for the rung marked >40% it states “TBD”. What is clear is I definitely would not go all in either.
Whether or not I can actually execute my plan (assuming the opportunity arises) is very much to be seen and I take your point about “more important things to worry about by that stage”.
Re: DeepSeek #38: bunged a few links on this into the “First they came for the call centres”.
I’m definitely the least qualified person on Earth to speak to technicalities of LLMs, but I’m reminded of what that Situational Awareness screed last year said about algorithmic improvements being as impactful as hardware (the author put it at ~3x p.a. improvement for each on the frontier models IIRC, so one order of magnitude overall annually.)
Be nice if the DeekSeek disruption boosted some of the smaller info-tech heavy UK investment trusts like SMT, Molten Ventures and Augmentum.
$465 bn of Schumpeterian creative distruction just in Nvidia (13% down now) just in one trading session (which is still ongoing as I type).
Nice though to see the deep value play old economy ITs like LTI only down very slightly, but really I think for full diversification from tech you need non equity asset classes here.
Anyway, here’s a take from Damo from a left perspective on DeepSeek (free to sign up on Patreon):
https://www.patreon.com/posts/ai-will-destroy-120806297
And from a right viewpoint, here’s an unusually good and short DT investment article today on the same:
https://www.telegraph.co.uk/money/investing/stocks-shares/deepseek-sparks-ai-market-chaos-is-now-the-time-to-buy-up/
At least the market carnage will have wiped that irritating smile off of Sam Altman’s face. On a more serious note is what are the implications of these breakthroughs for the Chinese state doctrine of civil-military fusion and are we loosing an AI Manhattan project? If it can do the same job for $6 mn that costs $7 bn for the US frontier models that suggests that Houston we have a problem.
@Al Cam: Extraordinary to think a 50% drop in S&P 500 would only bring it back to the long run average P/E! So the diamonds and Glock can wait for the 80 per center.
I like ITs as part of a ‘core and satellite’ approach. ITs give me access to leverage, alternatives, and private holdings. And they are close-ended, which is better than open-ended for such investments. I wouldn’t buy an IT which is simply an active equity fund. I suspect those will go the way of the dodo.
An interesting set of comments that have veered from investment trusts to the impact of global market cap indexes being overweight in the Magnificent 7.
I have no knowledge of ITs, and now may not be the time to dip my toe in that particular pool.
On the US tech bubble and its impact on my portfolio, the question is, what is a poor passive investor to do? I have been busy simplifying my portfolio so that when I kick the bucket, my partner has a simpler job of keeping her head above water. A global equity index holds all of my equity investment. What do I possibly have the knowledge to change at this point? Nothing. I am not your flinty-eyed, nerves-of-steel active investor. Just a miserable cowering passivista.
I could go more defensive, but gold freaks me out (I see it as a pure gambling throw, closely related to bitcoin), and commodities are also speculative. I think I will have to stick with bonds and cash as the main defensive asset.
I did check whether the DeepSeek announcement had trashed my global equities fund. Yes, it is off by 2.4% (so far). However, my 60:40 portfolio is still up on this time last month by 1.7%.
Just more evidence I know nothing, I guess. Maybe even reading Monevator comments is becoming too exciting!
@Wodger. Just a last thought. These days, my benchmark is more focussed on my relative wealth than outright wealth. I’m see myself in competition with those working in big seven tech or those Bitcoin HODLers. I see my biggest risk as a continuation of a major bubble in things such as tech equities, bitcoin etc.
So while I tilt toward large cap tech and tend to own calls on them, that’s in the context of a relatively modest equity exposure in my overall portfolio. Frankly, I’d be as happy as a clam if the big seven halved in value and bitcoin went to zero! Thing is if NVIDIA went down 90% today, it still would have more than doubled in value over the last five years. Being long FTSE dividend stock just doesn’t cut it.
@ZX #48: “own calls”: sounds a bit like these guys:
https://www.lesswrong.com/posts/JotRZdWyAGnhjRAHt/tail-sp-500-call-options
Shame can’t ‘insure’ against FOMO on keeping up with Mag 7 momentum chasers by using long dated calls in a tax sheltered account (or indeed via a retail focussed platform for me).
Prefer that personally to having to keep a high % in SPX to avoid missing out, whilst constantly having to turn over in my mind just how ***t I’d feel if the US then goes & crashes 50% plus, like in 2007-09.
@ZX — Interesting perspective. I remember you alluding to relative wealth vs tech workers previously. Personally, my aims are more in line with @TA’s modest FI income, so I only care about being able to keep pace with the cost of living for a median earner (or thereabouts).
TI – Sorry, but it’s Tolkien, not Tolkein.
To add to the links on the effect of passive flows on valuations, as summarised at my earlier post (on 30th September 2024, at #11), which was itself linked to under my post #27 above; here’s the latest today from Mike Green:
https://open.substack.com/pub/michaelwgreen/p/back-to-our-regularly-scheduled-programming
@DH — “lost decades” sounds very worrying, but where’s his evidence? Sounds like doom-mongering to me.
Having said that, I get the impression that passive investing would be a lot less problematic if it really did buy the entire market, without the rounding error at the small end of the spectrum.
Hi @Wodger: re possible ‘evidence’ (per #53), suggest checking out all the links in my 30/09/24 post #11 (itself linked to at #27 above).
Although I’m no ‘CAPE crusader’, prophesying the ‘inevitable’ reversion to mean based only upon a single ratio of past inflation adjusted profits in a single 10 yr period compared to the current index price, it’s fair to say US large cap index levels are high given everything.
Even back in 2023 (i.e. before AI hype went parabolic, before the fever dream of Trump deregulation and tax cut hopes injected some animal spirits, and before rate cut expectations became a backdrop expectation) the US was already sporting a CAPE of nearly 29 compared to just 7 (or thereabouts) for South Korea and Turkey.
If I had to guess here then there’s more chance, I’d say, of a decent decennial return out to Dec 2034 in those latter two national stock markets than in the former.
But the pathway there could be really weird and counter intuitive if Green is remotely right.
Once we get to 68-72% passive share on the S&P 500 then his toy model looks like suggesting (just eyeballing his chart) an index level at over 4x what the value would otherwise be without any passive flows (compared to less than 2x now at a 44-48% passive share).
*If* that were to eventuate, then it might mean the S&P 500 hitting anything from say 10,000 right out to 25,000 in around 5 yrs (assuming passive share increases linearly at current rates), compared to a fully non inflated level under his model of maybe 2,500 to 5,000.
Bonkers stuff, but stranger things have happened (and often do). Time will tell.
Apologies. Just spotted that my reference to the links I included in my previous comments to an earlier (@Finumus) piece were on 20th September (comment #11) last year not 30th. Anyway, for ease of cross reference here’s the link to that comment with the list of links to the research:
https://monevator.com/passive-investing-edge-and-market-efficiency-winners-need-losers/#comment-1836533