Billionaire Paul Singer is warning of a growing and menacing threat: passive investing.
"Passive investing is in danger of devouring capitalism," Singer wrote in his firm's second-quarter letter dated July 27. "What may have been a clever idea in its infancy has grown into a blob which is destructive to the growth-creating and consensus-building prospects of free market capitalism."
Almost $500 billion flowed from active to passive funds in the first half of 2017. The founder of Elliott Management Corp. contends that passive strategies, which buy a variety of securities to match the overall performance of an index, aren't truly "investing" and that
index fund providers don't have incentive to push companies to change for the better and create shareholder value.
Elliott, whose main hedge funds manage $33 billion, is best known for its high-profile activist and distressed wagers, including leading a group of holdout creditors seeking repayment for positions in Argentine debt. One of Singer's most recent campaigns — a bid to buy power distributor Oncor Electric Delivery Co. — has pitted him against billionaire Warren Buffett.
"In a passive investing world, small shareholders have little-to-no voice and no realistic possibility of banding together, while the biggest shareholders have no (repeat, no) skin in the game so long as the money manager does not underperform the index by five-hundredths of a percentage point, in which case the customer calls up the money manager and starts yelling," the letter said. There's a real likelihood that passive investing "and its apparent stability, is unsustainable and brittle."
Singer's Elliott Associates fund rose just 0.4 percent in the second quarter, bringing gains for the first half to 3.5 percent, according to the letter. While it made money in bets on distressed securities during the quarter, the fund lost on commodities and portfolio protection related to interest rates, equities and credit.
In a wide-ranging letter that touched on topics from safe spaces to infrastructure spending, Singer said the fund was trying to navigate "uncharted waters" amid continuing accommodative monetary policy.
The letter said that while economic optimism stemming from the Trump administration's pro-business agenda may contribute to rising markets, central bankers probably played a bigger role.
A de-linkage of stock and bond prices may be coming soon, if an expanding economy spurs inflation, making yields unsatisfactory to investors. Growth and inflation may climb together if rising rates are seen as a sign of confidence in the economy.
"The Fed's (and other major central banks') obvious determination not to let equity markets fall may be the chief underpinning of investors' willingness to hold (and accumulate more) equities even at current relatively elevated levels," the firm said.
More highlights from the letter:
• On whether the labor market is tight: "Short answer: no," Singer wrote. Long-term government benefit programs provide strong disincentives for people to work or even seek employment, and these people often disappear from employment statistics. It's hard for workers to be retrained, he said. Slow wage growth demonstrates that there's more slack in the job market than there may appear.
• On Chinese debt: In the event of a Chinese financial collapse, "large flows of capital during any unwind of highly leveraged institutions and structures would go coursing through the global economy and financial system like a wild tsunami," Singer wrote. Even if the government were successful at instituting capital controls, this would remove China from the demand side of the global economic picture.
• On safe spaces: Singer said in the letter that safe spaces are created so "fragile-as-eggshells students are not 'assaulted' by opinions or thoughts that differ from those in their 'Little Red Books.'" He compares this to central bankers who are "treating every single hiccup and little twitch in global stock markets as worthy of calming words and the promise of action 'as needed.'"
• On commodity trading: Trading in this area was unprofitable in the second quarter, led by losses in crude oil and U.S. natural gas. Losses were partially offset by gains in European natural gas and power and metals trading.
Elliott's largest distressed positions, in alphabetical order: Caesars Entertainment Operating Co., Drillships Ocean Ventures Inc., Energy Future Holdings Corp., Lehman Brothers Holdings Inc. and Nortel Networks Corp.
The firm's largest equity positions: Arconic Inc., Bank of East Asia Ltd., BHP Billiton Ltd., Citrix Systems Inc. and Hess Corp.
