Elon Musk, Cathie Wood say passive funds have gone too far

Elon Musk and Cathie Wood criticized passive investing in a Twitter thread, weighing in on a long-running Wall Street debate about the growing power of index funds.

Their discussion was sparked by venture capitalist Marc Andreessen, who said firms like BlackRock Inc. have outsized voices in many corporations because of the voting power attached to their huge passive vehicles.

Musk, chief executive officer of Tesla Inc., replied that passive investing has “gone too far.” Wood, who founded Ark Investment Management LLC, took up the conversation, noting that investors in S&P 500 trackers missed out on big gains in Tesla before it was included in that index.

“History will deem the accelerated shift toward passive funds during the last 20 years as a massive misallocation of capital,” Wood said.

Wood is one of the most high-profile active managers but has suffered a bruising year, with her flagship ARK Innovation ETF slumping almost 45%. Meanwhile, Tesla’s weighting in many major benchmarks means that indexing pioneer Vanguard Group and BlackRock are the electric-vehicle maker’s second- and third-biggest shareholders after Musk.

The debate over the risks of indexing — which funnels cash to stocks on autopilot, often regardless of company fundamentals — has been building for years as passive funds relentlessly grab market share from their active rivals. Their lower costs combined with doubts about the ability of most discretionary managers to beat the market have fueled the shift.

But the contours of the argument are increasingly complex. For starters, active managers are using liquid, easy-to-trade passive funds within their strategies. They’re also issuing their own exchange-traded funds — traditionally indexed vehicles — to lower costs and promote access, as well as creating strategies that blur the line between indexing and stock picking.

Meanwhile, there has long been a hidden human hand behind most passive strategies, from writing the rules of every index to deciding how each fund will run.

One study last year by academics at Cornell University and the University of Technology Sydney concluded that overall activeness of investment in the U.S. equity market has barely changed over the past two decades.