We live in a world where fund managers can become superstars, even if their results are not that great at times. All that’s needed is a big personality and a publicized platform to make their views known from. There have been a number of managers that have gained notoriety in this way, ranging from Jim Cramer, to Martin Shkreli, to Bill Ackman. These people have all managed funds at one time or another, and they’ve all made headlines because of their outspoken personalities. However, it wasn’t their personalities alone that made them famous. They’ve also gained publicity for being in positions of authority when it came to the markets.
Right now, Bill Ackman is the only name on that list that currently manages a hedge fund. And his recent comments about a possible “index fund bubble” have been met with intense scrutiny. Bubbles usually mean bad things, but without knowing what Ackman meant, the comment is completely meaningless.
Basically, what Ackman was driving at is the fact that mutual funds, index funds, and ETFs are becoming more and more widely used thanks to easier accessibility. These funds are gaining more and more capital, shifting corporate ownership from a handful of private individuals to a handful of fund representatives that are buying those stocks for their funds. In the end, a gradual change in ownership of a company occurs. And that means that the fund managers become the ones that can vote most heavily in corporate board decisions, and not the people that are most closely. This can lead to bad corporate decisions, passive voting, and other destructive company practices, and in turn, lead to a decline of the companies that are owned. This would, in turn, drive down the value of indices. And the people that are hurt the most by this are the people investing in the funds.
Another argument made by Ackman is that closet indexing is occurring. Essentially, this bloats the value of companies within an index—think of the exclusive membership of the Dow Jones Industrial Average—and drives down the price of companies outside of the index. But, over time, true prices must come to the surface. What ends up happening (theoretically) is that indices become overpriced, and companies outside the index become undervalued. The end result that Ackman is warning of is that indices could have a bubble “pop” and their prices could fall rapidly.
This is actually a really good point, albeit coming from a personality that is not well liked. However, Ackman did not become the manager of the biggest hedge fund in the world without cause. Yes, he’s made some epically bad decisions recently, but his advice here is pretty sound, and needs to at least be considered. This is one of the many reasons why investing and trading on your own only adds an extra element of protection to your wealth. Every fund manager in the world will stress to you how important diversification is, but they won’t often tell you that you can diversify outside of your own set of funds and blue chip stocks. You can diversify with different assets and different timeframes. In this respect, things like Forex trading, binary options, day trading, and so on, actually can add a ton of value to your long term wealth goals. Active trading is a lot harder than passive investing, but when done right and included as a part of a bigger overall strategy, trading, although considered risky, can add an element of security to your overall portfolio. It might sound contradictory, but even “risky” day trading can be a safety net of sorts when approached correctly.