This post by Robert Leitz has been excerpted from a letter of iolite Partners.
“I skate to where the puck is going to be, not where it has been.” –Wayne Gretzky
While active portfolio management has come under heavy criticism for good reasons, it is equally foolish to condemn it altogether. I strongly believe it is possible to beat the market over time and that the meteoric rise of index funds actually leads to more misallocations and hence more opportunities for active managers.
Contrary to common belief, the world of indices and index funds is packed with pitfalls for skilled and unskilled investors alike. Perhaps the most obvious flaw of most indices is that they overly favor current market darlings rather than those that will be. As a result, index investors tend to buy high and sell low, and with more money pouring into ETFs, these flawed dynamics are getting worse.
The rise of passive capital also means that huge pools of capital are available to companies and market players without any oversight. This trend will only strengthen with the structural shift towards computer-driven investment strategies. As somebody put it to me: “the rise of index funds is the end of capitalism as we know it”. The market needs active and engaged managers to help promote healthy levels of corporate governance. Shareholders are owners of businesses, and the key question is: who fights for their rights and interests if they don’t use the voice they’ve been given?
Followers of my portfolio know that I prefer not to talk about my positions. This helps protect me from various biases that negatively impact performance, such as ownership and social proof biases. It also helps protect my clients and copy-cats, as they are subject to similar biases. However, sometimes I have to break this rule to help protect the value of my positions. Over the last two years, there were two instances when I spoke out publicly. Not because I wanted to, but because I felt it was necessary.
In the first case, Perion Network (Nasdaq: PERI), the CEO committed huge capital allocation mistakes that destroyed hundreds of millions of dollars in shareholder value but still benefited him personally. He and the company’s board failed to acknowledge his mistakes even when they became blatantly obvious. Only once shareholders (including myself) started to speak out, with force and in numbers, the board felt pressured enough to initiate a change in leadership, direction, and attitude. While Perion’s turnaround is still in an early stage and we don’t know its outcome yet, I am pleased with what I have seen and heard from its new CEO, Doron Gerstel, thus far.
In the second case, Jumbo Interactive (ASX: JIN), the CEO (who is also the founder and a major shareholder) recently gave shareholder value away by strongly favoring one — Tatts Group (ASX: TTS) — of two strategic bidders for the company. While he seized the moment to strike a deal that materially de-risks the business going forward, I believe a much better deal could have been struck if he had let a normal auction process run its course, allowing Jumbo to be sold to the highest bidder and likely driving Jumbo’s share price substantially higher than June’s close of AUD 2.66. Unfortunately, it didn’t come to a bidding war, but Jumbo recently did pay a special dividend and materially increased its dividend payout ratio – as independent shareholders had demanded for a while.