The Real Bubble Has Always Been in Active Management

Michael Burry joins the chorus of people referring to indexing and passive investing as a bubble. It’s not his main point – which is that value small caps are being ignored, which is true – but it’s a point we now hear tossed off on a daily basis as casually and nonchalantly as though the speaker were simply saying that water is wet or LeBron James is good at basketball.

Most of the people referring to passive investing as a bubble have not accurately described the way in which it represents a bubble. What they’re really saying is that it is popular. So is shopping online and using Instagram and eating Mexican food. These things aren’t “bubbles.”

The term bubble, in the financial vernacular, represents something that is highly speculative in nature and surrounded by so much unbridled enthusiasm and untempered greed that it is unsustainable and due to blow up spectacularly. This is a terrible description for the current preference for low cost funds and low maintenance investing strategies. People using the term “bubble” to describe the newfound humility among ordinary investors (and their financial intermediaries) are either bitter, deliberately trying to mislead or mistaken.

Michael Burry’s a brilliant investor and has accomplished something in the market that 99.99% of all other investors could not or would not be able (willing?) to do. He especially ought to know better.

The real bubble is in actively managed funds. But we’re nowhere near that bubble’s peak, which was in the mid to late 1990’s. It’s been slowly deflating since the Great Financial Crisis – the moment the Boomer generation truly fell out of love with investing as a pastime or a recreational activity permanently. There were no more star stock managers from that moment forward, as almost all of them blew up along with the indexes and averages. The investor class then said to itself, subconsciously, “Why bother, I’ll just own the indexes and averages.”

From 1987 through 2007, we had a twenty year bubble in investor preference for active managers and stockpicking as a sport and investing as a hobby. In 1989, Peter Lynch’s book “One Up on Wall Street” came out and Warren Buffett’s status as a crossover celebrity began to take shape. The iconic brands and corporations of the mid 1980’s – like Coca-Cola and Nabisco and AT&T and IBM – became revered by the investor class and owning their shares became a token of success, their logos the emblems of Yuppiedom. This led to the inaugural broadcast of CNBC, the mainstreaming of BusinessWeek and Fortune and Forbes, and, later into the next decade, the rise of TheStreet.com and Yahoo Finance.

And as the 1982-1999 bull market gained steam, stock-picking mutual fund managers became household names. Celebrities began appearing in television commercials for do-it-yourself online brokerages, promoting a message that even truck drivers could one day buy their own island and anyone who wanted to begin trading stocks could one day become rich. Movie stars, tennis pros, famous basketball coaches and even Jackie Chan appeared in these spots for Ameritrade, Schwab, Waterhouse, Olde Discount, ScottTrade, eTrade, DLJ Direct, Fidelity, etc.

And then it fall came crashing down as the millennium rolled over. Whatever enthusiasm the dot com bubble and bust didn’t destroy in 2000-2002, the credit bubble and subsequent Great Financial Crisis would finish off just a few years later. By 2009, the Boomers were ten to fifteen years removed from the heyday of enjoyable active management and they were done with it. Later generations had never truly experienced that moment in time, and so never became enamored with the idea of recreational trading (until Crypto and Robinhood, both creatures of the latter twenty-teens decade, both very far removed from anything even remotely representing “investing” activity).

The active management bubble produced massive asset management companies that have been shrinking every year, despite the rise of both the bond and stock markets over the last decade. They are declining in headcount, advertising spend, product offering, investor awareness and prominence among the Fortune 500. None of this is abnormal – they were mostly too big in the first place, the beneficiaries of a bubble environment that hasn’t existed for over ten years now.

The twenty year period from 1987-2007 was the real aberration. What’s happening now is a reversion to normalcy. 

Prior to Peter Lynch’s books, the celebrity of Buffett, the all-day news channels and websites devoted to chronicling stock prices, etc, the vast majority of people were passive investors. But they didn’t realize it. The predominant form of retirement investment was happening out of their hands, and in the hands of the massive pension fund management and administration complex, all over America. You traded your best thirty years to a corporation or a union or a government agency in exchange for someone managing the money behind the scenes that would one day represent your retirement. You didn’t see your pension’s money manager face to face or have conversations about the stocks and bonds he was buying. You didn’t feel personal ownership over the investments themselves. You were merely a passive investor, awaiting your investments to turn into a stream of income upon retirement.

And if you owned individual stocks in the 30’s, 40’s, 50’s, 60’s, 70’s, it was because you were in the upper class or you had a very savvy parent or grandparent that had accumulated these investments. Often, they were in the form of stock certificates, held passively in an attic or a binder or a safe deposit box. Another possibility is you worked for a company that distributed shares as part of compensation or severance or to commemorate some long anniversary of your labor at the company. My wife’s grandmother had hundreds of shares from the various Baby Bell telephone companies she worked at in the 60’s, 70’s and 80’s. She was not an “active investor” simply because she held these shares individually as opposed to within an index fund. American households owned stocks individually prior to the aberrant period of stock market enthusiasm – but they weren’t operating under the delusion that they had the ability to trade against everyone else successfully, or that they ought to be spending their free time trying. They may have owned stocks, but they weren’t active investors.

Speculative bubbles in stock market activity and enthusiasm had come and gone since the beginning of our nation – first with canals in the early 1800’s, then with railroads fifty years later, then during the electricity and automobile boom of the 20’s, etc. But these were manias. They came and went. They had nothing to do with investing per se. They were gambling opportunities.

Pensions were the first form of investing that had ever caught on among mainstream American households. And their role in how these pensions were invested was almost non-existent – entirely passive. Once they were given domain over their own retirement funds in the shift from defined benefit pension plans to defined contribution 401(k)’s in the 80’s and 90’s, the brief dalliance with stock market fun and candy took hold, and an entire superstructure of fund companies and financial media had erected itself around them. What you are witnessing now is the slow and steady dismantling of this structure. It’s been over for a long time, but the realization has only become apparent in the last few years.

The popularity of passive investing isn’t new at all, it’s a throwback to the days of people focusing on their own work and careers, not trying to pick managers and become part-time market speculators.  You can never have a bubble in humility, apathy and passivity, which had always been the status quo up until the ’87-’07 period and is the more natural posture for investors to adopt for the future.