Nvidia (NVDA) reports results today after the market closes, like thousands of public companies in the last couple weeks trying to generate alpha.
The difference between Nvidia and most of the rest – about 99% – is Nvidia right now generates alpha, a superior return without additional risk (but it may not tomorrow).
CNBC just had its 14th Delivering Alpha event, on finding “risk-adjusted returns,” as the hedge funds say. Says CNBC: For investors, Delivering Alpha is paramount.
Well, clearly not. We’ll get to that.
And every earnings release on the wires – save the growing numbers we’re helping companies rethink – attempts to set its authors apart as superior, delivering alpha.
Yet Apollo CEO Marc Rowan told CNBC’s Andrew Ross Sorkin in a 2023 interview at the Economic Club of New York, “There is no alpha in public equities. Hasn’t been for 20 years. And 85-93% of active managers fail to consistently beat the benchmark.”
So, who’s right? Thousands of public companies grinding in the equity market, banging heads against the bricks, chasing alpha? Or Marc Rowan?
Now, if you’re reading this on your phone and you’re the investor-relations officer for a public company, and you want to throw the phone in a lake and scream a four-letter word, like suck! Hear me out.
There’s an easier way to deliver the investment product that the market wants. Contrary to popular belief, most of the money does not want alpha.
First, what is the addressable market? You might say, “Well, I target investors that we think should own our stock.”
Okay. Are they buyers? Do they have inflows?
The addressable market for public companies is THE MONEY. Not “investors.”
I bet 90% of c-suites don’t know that the average active fund is a net seller. For more than 15 years, data from the Investment Company Institute show (you longtime readers know I’ve written this thesis before), actives have lost $500 billion a year to passives.
It’s not just that active funds are managing outflows. When you’re a net seller, returns erode. You have to sell things at inferior prices to raise funds to meet redemptions. You hold more cash to reduce adverse selling – which erodes returns.
Mike Green from Simplify Asset Management told me that the Vanguard Total Stock Market Fund (VTSAX), the world’s largest index fund with $1.7 trillion of assets – making it by itself the seventh largest money manager in the US – holds only about $30 million of cash. Nobody sells it. It costs four basis points.
Compare to Capital Group’s $290 billion Growth Fund of America (GFFFX), the largest actively managed fund. Performance is about the same, top holdings about the same, but it costs 0.4%, ten times as much as VTSAX and holds $1 billion of cash, for redemptions.
SPY, an ETF you buy or sell like a stock that reflects the S&P 500, slightly beats both.
Well, then, why pay ten times more?
Today’s dominant investors don’t want alpha. They want beta – the performance of the market (it’s not volatility but how the market moves). Blackrock is paid for beta.
Only one thing derails index funds and ETFs tracking a benchmark. Volatility. If variance versus a benchmark or basket tops 2%, funds can be fined by regulators for failing to adhere to the prospectus. Distributors may stop selling them.
So the money and the market concentrate into stocks with less than 2% tracking errors. That’s how Passive Large Cap Blend became the largest equity asset class with 55% of assets. And 95% of market cap is in the Russell 1000. Ninety percent is in the S&P 500. Eighty percent is in the 115 stocks with $100 billion or more of market cap.
But Tim. NVDA is volatile. It’s a huge Passive stock.
It’s too big to exclude. But you’re not. Blackrock, Vanguard, State Street et al – there are now $10 trillion of assets in ETFs in the US equity market alone – buy the herd. Not the outliers.
Here’s what one of our newer customers said this week:
As you promised, the switch to the new process went off without a hitch and not a single person has mentioned it. To me, that is a huge win. I’m eager to hear how it impacted volatility. Certainly the advice to report today versus Friday was exceptionally sage and much appreciated.
Friday was options-expirations by the way.
We are helping public companies deliver beta because it’s what money wants. And it’s a big addressable market that seeks a scarce PRODUCT called “the herd.” Cozy up to the herd with your characteristics, not your story.
We were driving back from Steamboat Springs yesterday and just into Grand County over Rabbit Ears Pass (which was in a full-on, whiteout blizzard and ten degrees) we saw a wolf. First we’ve seen.
The wolves of the market go after the outliers trying to create alpha.
If you’re frustrated by volatility with earnings, and you’re a NIRI Virtual Chapter member, join the Café Chat tomorrow. I’ll discuss what’s causing it and how to dampen it.
And if you’d like to deliver beta, ask us. We’ll show you how to take the stress out of earnings, how to join the herd.
