Mike Green, the man who has done more to educate the investing community about the major flaws in passive investing, educates Barry Ritholtz on the fragility of the indexing craze.

Mike Green Educates Barry Ritholtz on the Major Flaws in Passive Investing

The man who has done more to expose the nonsensical foundations of passive investing, Mike Green, is at it again. The portfolio manager at Simplify Asset Management and former investment advisor to Silicon Valley tycoon Peter Thiel recently responded to pushback on his passive investing thesis from Barry Ritholtz.

For the uninitiated, Ritholtz is Chairman and founder of Ritholtz Wealth Management, an investment management firm in New York. Ritholtz and his partner Josh Brown are often on financial media, pushing the passive investing investing narrative that has carried them to great wealth.

It appears Mr. Ritholtz is afraid to engage Mike Green directly, as he did not reference Green’s Twitter handle @profplum99 in this exchange (Ritholtz is still struggling to respond to David Einhorn’s well-argued points on how passive investing has broken the stock market):

Mike Green responded:

Green is discussing a key dynamic in today’s passive-dominated markets: target date funds. These funds are now held in virtually every 401(k) by default, and their simple algorithms can move hundreds of billions of dollars on autopilot. This has made the markets demonstrably less efficient, as documented by many academic papers.

Green explained that when the Fed sharply raised rates in 2022, this pushes the value of bonds down. As a result, target date funds must sell stocks and buy bonds as their algorithms dictate, in order to keep investors’ stock and bond percentage allocations in the designated ranges.

Mike elaborated in previous interviews that this rebalancing was the biggest factor in the S&P 500’s -19.44% return in 2022. After that passive selling abated, the market was free to surge again on the back of the ever-present mindless index fund bid, fueled by regular retirement account inflows from workers’ paychecks.

As is typical with passive funds, valuation or business prospects are never considered. This has led to the dynamic where stocks have ignored the Fed’s aggressive rate hikes and long-term bonds have failed to catch a bid despite inflation peaking many quarters ago — an unusual situation historically.

The reason is that passive funds do not consider the relative attractiveness of these assets. We wrote more on this on Passive Parabellum in our post, Now Passive Investing is Breaking the Bond Market.

Suffice it to say, critics like Ritholz do not have a good argument against the gaping flaws in the passive investing model. For now they are riding high on the ever-present passive bid as markets surge unabated. However, as Mike Green is fond of saying, the current state of the indexing craze is like driving uphill with no brakes.

There Are Major Flaws in Passive Investing and the Indexing Model

Trouble will come once we reach the top of the hill, i.e. passive funds experience sustained net outflows for the first time. Their sheer size relative to the market (now approaching 50%) and society’s aging demographics make this a question of when and not if.


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