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    observer effect

    The Observer Effect | Shares for Beginners Podcast

    Tamas Calderwood, Distributions Specialist at eInvest, was recently featured on the Shares for Beginners Podcast with Phil Muscatello discussing The Observer Effect coming to the share market. Listen to the podcast above and enjoy the article below as an extension to his discussion with Phil. Thank you Phil for having us on your podcast once again. (click here to see the last time we were on Shares for Beginners podcast). 

    What is The Observer Effect?

    When you stick a cold thermometer into a warm glass of water you get a reading of the water temperature, but that measurement will be slightly cooler than what it was before you stuck that thermometer in.  This “observer effect” applies to countless physical and social phenomenon: measuring an electrical current creates resistance, which changes the current; informing your staff that you will now be observing their start time every day will probably affect what time they turn up.

    And now, in a multi-trillion-dollar global experiment, the observer effect has arrived at the heart of finance:  welcome to passive investing.

    The role of passive investing

    In my podcast with Phil Muscatello on “Shares for Beginners”, I discuss that the role of a financial index has traditionally been as a measuring tool.  For equity indices, the aim was to measure market performance and sector weights.  These measurements could be used for benchmarking fund manager performance as well as general market insights.  Then, an epiphany struck the investment world:  a stock index turns into a pretty good portfolio.  It will not outperform the market, but it won’t underperform either.  Combined with low fees that come with simply tracking an index, passive investing boomed.

    There have always been concerns about how big passive investing could get before it began to influence the markets.  Everyone agrees that, logically, passive funds cannot make up 100% of the share market.  Price discovery requires some active players in the market to trade and discover prices.  When passive hit 10% of the US share market, few were concerned.  Same at 20%.  By the time it was 30%, a few participants were starting to take note of the effects it may be having.  Today, the US market is 43% passive.

    This money has mostly flowed into large, broad, market-capitalisation based index funds.  However, the success of passive investing has spurred the creation of a vast range of new indices:  Thematics (robots, anyone?  Or how about a technology index?) and more technical “factor based” indices (Minimum Volatility, Quality, Value, etc).  Many of these indices have been specifically designed as portfolio trackers rather than as pure measurement tools.

    Overlapping holdings

    Another issue is that while many of the indices are designed to capture different segments of the market, they often hold many of the same stocks.  For example, an investor may want some broad market US market exposure through the S&P 500.  The top holdings are Apple, Microsoft, Amazon, Facebook and Google (Alphabet).

    The investor may then like some technology exposure and therefore buy a Nasdaq 100 ETF.  The top holdings are Apple, Microsoft, Amazon, Facebook and Google.

    Then, seeking some international exposure, an investor may buy an ETF tracking the MSCI World index.  The top holdings are Apple, Microsoft, Amazon, Facebook and Google.

    Finally, the investor may like to hold an ETF tracking the MSCI World Quality index.  The top two holdings are Apple and Microsoft.

    Circularity of measuring

    With so much money flowing into passive funds and with many of those funds holding lots of the same names, the indices that were designed to measure the market have switched to becoming active players in the market.  The circularity of measuring the market with indices that are tracked by almost half the market in the US has started to lead to funky outcomes, such as the recent shenanigans with Tesla.

    The observer effect is a well-known phenomenon, but its impact on the share market via passive investing is brand new, little understood, and happening right now.  Buckle up because the funky stuff has only just begun.

     

    This article and podcast is part four of a series written by Tamas Calderwood on the risks on investing in the index. Read parts one to three there.

    1. Tesla, the S&P and Passive investing
    2. Tesla and the soft dictatorship of the index
    3. Passive is massive, so Tesla got dumped

     

    Disclaimer: Please note that these are the views of the author, Tamas Calderwood, Distribution Specialist, eInvest and is not financial advice.

    To find out how to invest in our active ETFs, visit here. The product disclosure statement and more can be found at www.einvest.com.au

    If you’d like to keep learning further, please feel free to follow any of our socials listed below.

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    Transcription

    Good morning and welcome back to Shares for Beginners. I’m Phil Muscatello. ETFs used to mirror the market. Now they are the market. Joining me today is Tamas Calderwood, distribution specialist at Investor Day. How’s it going? Good, thanks Phil. Thanks for having me on. Always a pleasure.

    He recently wrote an article that covered Tesla and its effects on the index, the S&P 500, which led to another article called the Soft Dictatorship of the Index. I love that name. Very poetic. So you’re a distribution specialist at an investor ETF providers. What’s that involve?

    That’s right. Well, essentially, it’s being a salesperson. So my job is to go out and put our funds in front of financial advisors so that they can use those funds for their clients in their clients’ portfolios.

    So essentially, sales, what do you do every day when you turn on the computer? What’s the first thing you do?

    Oh, you know, like everyone check e-mails, I suppose. And a lot of work is done via email. That’s how we get in front of a lot of people, but also phone calls. So, you know, follow up with phone calls to make sure people are seeing the information, checking whether they need anything else. And, you know, a lot of cold calling as well, going out and calling people for the first time and introducing ourselves.

    What’s the financial planning industry like? I mean, I know there’s a lot of people who think of the end of the local financial planner that they might meet at the local association or at the pool with their kids. Is that where you’re targeting or are there other, I guess, equal distribution channels?.

    I mean, we have stockbrokers as well that we talk to. But financial advisors, I mean, it’s an industry that has gone through a lot of turmoil lately. Of course, because of the royal commission, the banks are all pretty much out of that business. And so a lot of them are becoming a lot more independent. And there’s a lot of very, you know, high quality advisors out there. I guess what’s been happening is they’re trying to weed out the ones that shouldn’t be in the business, those that haven’t performed well and haven’t put their customer first. And yeah, I think we saw a lot of that with some of the scandals about fees for no service and so on. But the industry itself, I think is a lot cleaner now, but it has contracted somewhat.

    There are less advisers in the market these days and there seems to have been a generational change as well. The new generation of financial planners have got two very different ideas about how to approach it.

    Yeah, I think also the government’s FASIA requirements, which is this training, and you’ve got to meet certain levels of qualifications. You know, a lot of older advisors that are sort of pushing into the 60s and the requirements would have essentially sent them back to university to do a full degree or something along those lines. And they’ve just, you know, hung up the boots and, essentially sold their books or closed it down.

    Yeah, they’ve just decided it. It’s all too hard for them at that at that particular age group. Yeah. Okay, so we’re going to be talking ETFs and eInvest is an ETF provider. And of course, you’re not providing any kind of financial advice here.

    It’s important to just say that up front. Thank you. It’s general advice only. We’re not giving you advice. If you want advice, please go and find a financial advisor. So what we’re having today is just a general discussion.

    Yeah. Don’t listen to us on anything.

    And please have a look at the PDS, the product disclosure statement of any fund that you’re considering buying, which you can find at our website, which is eInvest.com.au.

    Okay, so let’s talk about indexes, because as far as ETFs go indexes or indices, I’m not sure exactly what the right term is.

    Yeah, Well, perhaps I can tell you a bit about my background.

    I worked at MSCI for around about thirteen years I suppose. Joined them in London, moved out to Sydney with them where I’m from originally and spent a decade or so doing the index business here.

    A lot of my job obviously was selling to ETF providers and getting them to use our indices as the basis of their ETF. And I guess during that time I really saw the explosion of passive investing and we were a big part of that at the index company MSCI. And it wasn’t just the large standard market cap indices that we had, which if you want me to explain a little further, but they’ve also released a lot of thematic indices these days. So quality, minimum volatility and other types of indices says it’s not just your standard vanilla index anymore. There are many, many different types of indices.

    MSCI that’s the mother of all indices, really, isn’t it?

    That’s the big international one. Yeah, that’s right.

    Yeah. You can track an index of every market in the world via the MSCI countries. That’s right. So it’s known as the Miski. Yeah.

    Miski – a lot of people pronounce it that way. It originally stood for Morgan Stanley Capital International. It was spun out of Morgan Stanley, but now just stands for MSCI.

    Sorry, I just wanted to break down some of the terminology here because it’s very easy to slip into jargon, but this is an organisation that creates indexes. It’s right. That’s right. So someone has to. Someone has to actually make an index. That’s right. So you’d have heard of S&P.

    Of course, we’re going to talk about them. FTSE is another one. Stoxx is another one. Dow Jones, which is now owned by S&P.  ASX 200 is produced by S&P, so someone needs to sit down and calculate these indices every day and they need to make a judgment about what stocks go into the index as well. And they’ve got a very public and well-defined methodologies in the ASX 200 case. It’s simply the top 200 stocks in Australia by market capitalization or by how big they are. Now, there are certain rules with the index as well. So they rebalance generally four times a year. But what you don’t want is that number 200 stock dropping to 201 and then back to 199 and then coming in out in out of the index. so they have what’s called buffer zones. And they generally widen it out to the 220 of stock or the 180 stock in order to fall out of the index or come into the index, respectively.

    So it’s not a hard relegations that’s like football.

    Yeah, there’s a little bit of art to these things. But generally they try to have methodology that is very transparent so that people can understand how this index works. And of course, that means people can generally tell what stock is going to go into the index and what stock is going to come out of the index as well. And with that, you have what’s called an index effect in that if everyone knows their stock is going to be put into the index, what that can mean is that a lot of money is going to have to buy into that stock because it will be part of an index that is replicated by a whole lot of passive funds and things like exchange traded funds or ETFs. So if a stock goes into the ASX 200 index and you own an ETF that tracks the ASX 200, then your ETF is going to have to put some of that stock into its portfolio so that it reflects the index.

    And this happened with after pay, didn’t it?

    After pay was in the index has moved up very rapidly. But when did it when did it actually into the ASX 200? I don’t know, off the top of my head.

    But it’s fairly new company and it’s over the last couple of years, over the last couple of years, blasted its way into the index. Yeah, that’s right. Yeah.

    And I suppose after a more traditional one, I mean, it has moved very rapidly up, but it came in as a small cap stock, moved into the mid-cap index, then became a large cap and, you know, progressed up that way. But in the case of Tesla and the S&P 500 in the US, it’s been a very different situation because it’s been outside of the S&P 500 and very rapidly risen in price. So it’s become a very large stock, in fact, the largest stock outside of the S&P 500. And that hasn’t happened before. They haven’t had a stock this big sitting outside of the index because normally it would have come in much lower, would have been the 400, you know, stock or 450. Its stock is something even if its price was going up, whereas Tesla now is well, I don’t know exactly where it’s going to be as sort of a top 30 or 40 stock.

    Look, just before we get onto Tesla, I want to go over some more of the basics. Yeah. So with a passive ETF, so we’ll give, say, the ASX 200 is an example, a passive ETF. How does that work? What’s it doing?

    Very simply, it’s building a portfolio of stocks that mirrors the index that it’s tracking. So if BHP is ten per cent of the index, then it will be 10 per cent of the portfolio that this ETF holds. And so that’s essentially just what it does now. I suppose I’d bring it back to a point that indexing was designed to measure the market, and it does that very well in both equities and fixed income indices as well. And these things were very much designed just to measure the market so that you could analyse the performance not only of markets, you could also tell the size of various sectors and so on, but you could also benchmark fund managers. So a fund manager would say that, you know, I’m really good at picking stocks. Why don’t you invest your money with me? And the way that you judge them is to compare them to the index. Did they beat the index? If not, well, why not? And you need to understand what drives the returns of those fund managers. And the benchmark can really help you to understand that. But in the process, I suppose, of, the last decade or just a little more, what people realised was that if you just passively track an index and of course you can do that with very low fees because it’s not hard to replicate a portfolio of a published index and have a passive ETF.

    They’re very a very, very low management fees, very low management fees in Australia.

    You can find them for under ten basis points. But what started happening was that people realized that just replicating that index with very low fees was actually a pretty good way to invest. And so more and more money started pouring into the passive fund industry, a lot of it through exchange traded funds. But you can also buy passive funds that your superannuation fund might run them or big institutions can hand over big chunks of money to a big fund manager, like a BlackRock or something and say just track the S&P 500 with that. They don’t need to buy an ETF. They get their own account run by a big investment company. And so people realize that this is a really good way to invest. And more and more money started pouring into it to the point now where in the US more than 40 per cent of stocks actually held by passive fund trackers, by ETFs or passive, you know, other types of passive funds. And so we’re getting to the point now where instead of just measuring the market, the index has become the market to a certain extent. And so any changes that are made to the index has this enormous effect on the stocks that are coming in or out of that index, because the the passive fund industry has just become so big.

    Now, people have realized this theoretically, that at some point you can’t go all passive. At some point it has to stop. You can’t be 100 per cent passive. And the reason for that is there would be no price discovery. Essentially, prices on stocks are discovered because someone thinks it’s not worth this much money. So they’re going to sell it. And then someone else thinks, actually, I think that’s worth that and they are going to buy it. And so a trade happens in the middle and you discover the price.  With an ETF, If you’re just buying into the passive market – and also as well, what’s also been happening is money has been coming out of active management and going into passive management – So all this money flowing into passive means that the ETFs are just buying whatever stocks are in the index, no matter what the price. So Afterpay is a great example that you raise before.  Afterpay has risen very, very quickly. It’s now a 30 billion dollar market cap stock. And if you were looking at that as an active investor, you might be, you know, hang on a second, maybe this thing’s a little overdone here.

    And I might sit on the sidelines for a while and just see where this thing goes. But if you’re buying an ETF, you’re buying into after pay at that price today. So you buy an ETF, the ETF then goes out and buys all of the stocks according to how they ranked in the index. And guess what? Afterpay ranked pretty highly in the index at a very high multiples, you know, valuation multiple at the moment and that’s what you’re buying. Now if you had of owned that ETF from the beginning when Afterpay came into it, you would have ridden that Afterpay wave. So you’ve done very well out of that. But what I do note is that if you’re coming into the ETF now, you’re buying in at that price. And that’s part of the danger, I suppose, of where passive investing is going.  It has become so big that the money flowing into it is buying these stocks at any price just simply because they’re ranked at that level in the index. And maybe if I could sort of bring Tesla up at this point with the S&P 500. Yeah.

    So you’re itching to do that? Well, Tesla. Yeah, because I think it’s just such a great story. It really shows this is reflected in your article as well. Yeah, that’s right. We’ll link to on the the blog post as well so we can say more in depth about what you’re talking. Yeah. Thanks..

    Well I mean this is where things start to get a little bit funky I suppose with the index and what’s happening. So as I said, Tesla is now a very large stock. It’s worth more than the next four biggest car makers combined, over 400 billion dollars in market capitalization. It produces less than 400000 cars a year compared to those four car makers that produce more than 25 million cars a year and make enormous profits on that. Tesla makes a tiny little profit and produces about 400000 cars a year. And it’s the biggest car company in the world by far by market capitalization. So, again, you might sit on the sidelines with that one and think maybe not Tesla right now. But if you buy an S&P 500 ETF, then at some point Tesla might come into the S&P 500. There’s no guarantees on this, but given the methodology of the index, it meets the criteria to be an index member. It’s current market capitalization would put it at around about one per cent of the S&P 500 index. Well, guess what? There’s about 11 trillion dollars that tracks the S&P 500 index one way or another. At least half of that is passive, which means at least around five or five and a half trillion dollars of passive money. If Tesla goes into the index, Tesla has to be one per cent of the portfolio of that, five trillion dollars indicates buying of more than 50 billion dollars worth of Tesla’s stock. And that could create a surge in demand for Tesla. Beyond what we’ve seen so far, that’s already driven it to these stratospheric levels.

    So as it comes, a snowball effect is they could.

    Well, yeah, and the other thing that we saw is that when S&P passed over Tesla at its last index review, Tesla’s market capitalization fell by 80 billion dollars in one day. Now, that was roughly at the time about the combined market cap of ANZ and NAB. Now, Tesla’s production hadn’t changed a bit. Its company hadn’t changed. Its CEO was still running it. Nothing had changed. The only thing that changed is that Tesla wasn’t put into the index and it fell by 80 billion dollars in market capitalization. Now, S&P has just kind of kicked the can down the road on this one a little bit because it said that it wasn’t going in, but they didn’t say anything else. They just didn’t say anything about Tesla. But everyone knows that it still qualifies to go into the index so long as it keeps its profitability up and, you know, given its market capitalization. So S&P are probably going to have to put it into the index at some point. People know that. And guess what? It’s back up. It’s regained all of that value that it dropped. Some of that, I have to assume, is on the expectation that it is going to wind up in the S&P 500 and that’s going to create a lot of demand for the stock. I guess the point of all this is that it’s a bit weird that something that’s designed to measure the market is now influencing the price of some stock so much and distorting these values so much that it’s becoming almost a circularity now where, you know, it’s so big that the thing it’s measuring is changing fundamentally because of the act of measurement, because it’s attracted so much money into passive investing that now it’s starting to distort prices. I guess we’re close to those levels that everyone said that, you know, can’t ever go above, I don’t know, maybe 50 percent or or higher. Well, guess what? We’re close to that now, at least in the US. Australia’s further behind. And so we’re not having these issues to the same extent that the US is, but we’re heading in the same direction.

    People think that passive investing is almost risk free. But it’s not. It’s not, is it? There is a lot of risk involved in that. As the market goes up, it’ll go up, but it can go down with the market as well. There’s nothing to protect that. An ETF reflecting what the market is doing at any particular point in time, not if you’re in an index tracking ETF.

    That’s right. Yeah. So, I mean, the risk you’re taking on is the overall market risk. You are buying into the share market at the levels that the share market is currently trading across those 200 stocks. If you’re buying a top 200 ETF and yes, that you are exposed to the equity market. So there’s another crash then. Yeah, guess what? Your portfolio is going down in value as everyone else’s is now. There are different ETFs that you can buy in different segments that may offer you some diversification. And you know, that way you can use ETFs to build a portfolio of different asset classes that could essentially de-risk your portfolios.

    That’s right, because people don’t understand that there’s other asset classes. You don’t have to be just in the share market. Actually, in our previous episode, we had Graham Hand and he talked about an ETF portfolio that track the Future Fund. So really, you’ve got you’ve got an allocation in cash. You’ve got an allocation in Australian shares, international shares, real estate and infrastructure and bonds as well. And these are all different kinds of asset classes, aren’t they?

    That’s right. Exactly. Yeah. So, an ETF can essentially be structured to buy any type of asset. But what’s unique about it is it trades in real time on the exchange. So you can have ETFs made up of bonds like some of the ones we have, like ECOR, EMAX, you can have ETFs made out of small cap equities or large cap. There’s all different flavors of ETFs, a remarkable statistic that I like to quote sometimes is there’s now more indices than there are stocks trading in the world. There’s so many different flavors of index that you can actually put together. And there’s, I think, more than 7000 ETFs trading around the world. So there’s a huge selection of these things that cover all asset classes. And you can build a great portfolio out of just using ETFs. But I guess the question is, do you want to be all passive? And that’s fine. But what we would point out is that there are areas where passive doesn’t make as much sense as going active and also other areas where passive is becoming so big. In the S&P 500 example I gave before is that it can start to distort the market somewhat as well.

    What do you call it, the soft dictatorship of the index? What’s it actually mean? What’s behind that?

    Yeah, well, I guess what I was getting at the you put into two categories. I guess there’s the hard dictatorship of the index and that’s the passive funds they have to buy. What’s in the index. They’ve got no choice. So if a stock’s going in the index, it’s going into that portfolio. And that’s that. No matter what the price, they are literally price takers, they just buy it wherever it is trading at the time. The soft dictatorship part’s a bit different because so many actively active managers in the US are benchmark to the S&P 500. And so are their performance fees, they’re going to get paid if they beat the index. So let’s use Tesla as an example. So they may not like Tesla and they may not be into the automotive sector. They think that they don’t want to own any car companies or anything like that. But guess what? If Tesla goes into the index, it’s one per cent of what they’re being judged against. And let’s say Tesla doubles in price again, it’s happened three times in the last year. So let’s just say that it happens again. Well, if they’re not holding Tesla, that means they’ve got a one percent performance drag compared to the index simply because they weren’t holding Tesla.

    Tesla’s one per cent of the index doubles in price. They weren’t holding it. They’ve got to make up that one per cent from somewhere else. So the soft dictatorship part, I guess, was just alluding to the fact that just because it’s in the index, these active managers have to take notice of it. They have to watch it. They have to make a decision as to whether they want to own it or not. If not, that’s still a risk for them because it could have a fantastic performance and they missed out on that. And if they feel that because of its weight in the index, they need to own some of it. Well, again, you know, they could be forced into by some of these very elevated levels of trading. So that’s the soft dictatorship part, is that the index itself has become so important, not just as a portfolio construction tool for passive funds, but as a benchmark for all of the active funds that they are now very aware of what’s in the index and what’s not in the index. And that influences the decisions they make as to which stocks they buy and which they don’t hold as well.

    Active funds can be managed funds and ETFs as well.

    That’s right. So there’s a difference in definition between those two, but it’s basically where people are paid to choose what what stocks they think are going to outperform others.

    Yeah, that’s right. So an active ETF is essentially a managed fund. It’s been wrapped in an ETF container.  A container and is put on the exchange to trade in real time. So the key difference, obviously passive has to track the index, it has to reflect the index or as active they can buy any stock that they want and build any portfolio that they want. There are some constraints. Obviously people sometimes say that we don’t want you holding more than 10 per cent cash or you can’t have more than six per cent of the portfolio in one stock and so on. There are some risk controls, but generally the managers are free to buy and sell whatever stocks that they want and that’s effectively what active management is.

    And so what you’re saying now is that active managers, because of the soft dictatorship of the index, are actually forced into purchases that they may not normally be looking for?

    Well, yeah, that’s right. The fact that the index itself, I suppose it we could talk about the nature of indices themselves a little bit, that they tend to be very top heavy. So, you know, your top ten stocks in the case of the S&P 500 account for 30 per cent of the index, you know, weight MSCI is a little lower. S&P 200 here is about 40 per cent is even more concentrated. If you’re a fund manager and you’re trying to beat the index, let’s say the big four banks, for example, are you going to have a position in the big four banks? Will, almost certainly, yes. Because if something happens to the banks, let’s say they have a big run up in value and you’re not holding them. Well, it’s going to be tough for you to beat the index. So there’s a bit of herding, I suppose, that goes on in that a lot of active managers feel that they have to hold a certain weight of stocks in their portfolio, whether it’s exposures to certain sectors or even certain stocks themselves, because they don’t want to risk falling too far behind the index. So I think there is a lot of that that goes on.

    And getting back to small caps, a lot of listeners are interested in more of the small cap companies because they have realised that this is where a lot of the action is taking place and where big gains are going to be made because they are going to be some winners are going to be a lot of a lot of losing losers in this space. But I think a lot of winners come from there as well.

    Look, every large company started out as a small cap, so there is a lot of opportunity in small caps. That’s one of the reasons why I am IMPQ is an actively managed small cap ETF is because we think that small caps is an area that needs careful consideration. There’s a lot of speculative companies in small cap index. They all just get put in the index because they’re listed and they have to be in the index, but a lot of them don’t warrant investor capital.

    And we think we’ve got a team that can sniff those ones out and put together a portfolio of stocks that can beat the small cap index, which is what it’s been doing.

    Because sometimes some of these companies don’t even have any revenue yet and they can move just on some announcement from the government and.

    Yeah, that’s exactly right. I mean, there’s some wild swings in the small cap space, I guess, as you sort of go up the scale a little bit, you know, things tend to become a little bit more traditional in that valuations are somewhat based on actual earnings and things like that. But in the small cap market, you can have some very speculative plays. As you said, companies without revenues or profits or anything like that that are worth billions of dollars because investors are making a bet on the future.

    So, yeah, very speculative in that space compared to sort of more traditional. Larger. Yeah. In fact, one of the the examples recently and of course, this is no recommendation to buy this one, but we had the chief technical officer from Haza on said pretty revenue, a company that testing hydrogen production. And of course, the government came out with their renewables plan a few weeks ago. And it was all about part of it was hydrogen and putting money and of course, their share prices going through the roof since then. And that happens quite a bit, doesn’t it?

    It does, yeah. I mean, that’s the sort of area dealing with the small caps is that you can get big surprises like that. And some announcements can literally change the value of the company by some multiples. You’re never going to get an NAB or a CBA tripling in price over a short period of time. But it can happen in the small cap space fairly frequently. I mean, the trick, of course, is to find those stocks that are going to do that and avoid all the other ones. But, yeah, that’s where you can find some veryvery rapid returns.

    Is there anything else you wanted to add about those articles and the points that you are making in those articles?

    I guess the point that the articles were addressing was that the passive investing phenomena has come so far now that we’re approaching a point where funky things are starting to happen, and Tesla is a prime example of that.  It’s become a huge stock very quickly, the index trackers are going to have to put Tesla in their portfolio if it goes into the index and the current valuation levels of Tesla are wild. I mean, it’s you know, it was over 400 billion dollars and by far the largest car company in the world. So if it goes into the index, all those passive funds are going to be buying lots and lots of Tesla stock. And the point is that the act of measuring the market, which indices were originally designed to do, has now affected the market itself because passive investing has become so big that the indices themselves don’t just measure the market anymore, they’ve become the market themselves. And so they’re so important now when a stock comes into or falls out of the index, there’s so much trading that goes on around that that’s really starting to affect pricing with many stocks simply because of the index membership.

    Is anyone actually going and picking stocks the old fashioned way? There must be someone doing that.

    Yeah, there’s still a few people around to do that. And I think it’s very important. I mean, look, I guess with passive investing, the argument has long been that if passive gets so big, that creates opportunity for active managers because it passive funds just have to blindly follow the index, then that gives active managers the opportunity to identify some of these overvalued stocks and sell them or look for undervalued stocks that aren’t in the index or not represented in the indices and buy them. I guess the problem with that has been that there’s just so much money going into passives that it’s created a momentum effect with a lot of the index members. You know, the passive funds just have to buy these stocks no matter what their price. And that means that the active managers have been getting burnt a little bit because they haven’t been able to compete, I suppose, with this wall of money that’s flowing into passive. But there should be an opportunity as passive continues to grow. It increases that opportunity for active managers to actually get in there and add value by picking stocks.

    Now, eInvest.com.au is all active management, isn’t it?

    That’s correct. Yeah. We’re only launching ETFs where we think active management makes sense. You think I can do better than the passive guys? Yeah, I think so. Look how small cap fund certainly has. I think our fixed income funds, ECOR and EMAX, are performing very well and they provide a very safe, steady income stream in that fixed income space. And our equity income fund, as you know, I think it was the high yielding equity income fund last year on the ASX.

    So to find out more information, we’ve got a special. You are all set up, haven’t we?

    Yeah, eInvest.com.au/SFBTamas,

    Tamas, thank you very much for joining us today.

    Thanks so much. Appreciate it. The company and your guest has contributed to the costs associated with producing this episode of Shares for Beginners, Shares for Beginners, just for information and educational purposes only.

    It is in financial advice and you shouldn’t buy or sell any investments based on what you’ve heard here. Any opinion or commentary is the view of the Speaker only shares for beginners. This podcast doesn’t replace professional advice regarding your personal financial circumstances or current situation. Thanks to Christopher Soulforce for music production with that special Greek delicious flavour. Remember, music always flows even when the money won’t.

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