August 31, 2022


Bill Miller once said, “Seventy percent of stock-pickers are closet indexers.”


The image at right is the composition of the daily average volume in SPY, the State Street S&P 500 Exchange Traded Fund (ETF), for the five days ended Aug 24, into index-futures expirations today.

SPY Demographic Volume Composition, 5D Ave Aug 24, 2022

It’s proof of what Mr. Miller said. I’ll explain. 

Miller, former Chief Investment Officer of Legg Mason Capital Management and now head of Miller Value Partners, is a legendary stock-picker.  Closet-indexing is owning what index funds buy to try to mimic performance.

You know what I mean by stock-pickers, right?  It’s bottom-up investors, or as we say in the investor-relations profession, the long-onlys, the investors you talk to.

It’s the money on your earnings calls, showing up on your non-deal roadshows (more jargon from the investor-relations profession), the buy-and-hold folks.

In 1998, using Morningstar data, the four largest investment-management categories were stock-pickers and they controlled 90% of assets under management.

In 2019, comparable Morningstar data showed those four – Active Large Cap Growth, Active Large Blend, Active Large Value, Active Other – were down to 50% of assets.  Data since suggests they’re down to 40% now.

In fact, just one category, Passive Large Cap Blend, now has close to 40% of all assets, the same data suggests.

And it fits other observable facts.  About 95% of market capitalization resides in large-cap funds. It’s a reason why we tell public companies to focus on becoming big.

Size matters. It’s where the money is. 

Were I running a company wanting to IPO, I’d roll up enough assets to value the entity at $5 billion first. We’d be in the thousand biggest stocks in the market –where the cash is.

Why go public and reside where it isn’t?  Common sense. Don’t let bankers fool you!

On Aug 25, the SEC adopted Pay for Performance rules included in Dodd-Frank legislation from a decade ago requiring public companies to tie compensation to total shareholder return, including share-performance.

Public companies should link pay to financial returns. Got no problem with that.  But public companies cannot control how shares are valued, because the great bulk of volume that sets prices isn’t directly motivated by the company’s story.

The two images here paint a stark picture.

In the top image, 19% of SPY volume is from stock-pickers.  SPY is the most actively traded stock by dollar-volume.  It averages over $30 billion daily, about three times what AAPL does.  And it trades about 500,000 times daily, about $50,000 at a time.

But SPY is a proxy for stocks, a substitute. Like all ETFs are.

Now, see the second image here.  It’s volume composition from the same period for the 500 stocks comprising the S&P 500 index that SPY tracks.

S&P 500 Demographic Volume Composition, 5-day average, Aug 24, 2022

Active Investment is 10% of volume in the average S&P 500 stock.

Get it? Active money is 90% higher in SPY than in the stocks it tracks!

And Passive money, which ostensibly indexes the stocks, is just 1% lower daily in SPY.

Meaning? Stock-pickers are closet-indexing not just by following indexes but by substituting SPY for stocks.

Which also means the probability that a public company can directly influence the value of its shares with its story and financial performance is 10%. Or less.

Perhaps far less, since even Passives are buying another passive instrument, SPY, over stocks comprising indexes.

So peg 5-10% of compensation to the stock.

It’s happening because it’s too hard to get in and out of stocks. What’s the SEC doing about that flaw? Nothing. They’re fixated on obsolete, anachronistic disclosures.

And these facts, and these two images, should preface compliance filings by public companies.  Every c-suite and Boardroom should be paying attention.

And why are we spending the same time, and ten times the money, courting stock-pickers if they’re buying SPY?

When I was the IR guy for a telecom, I traveled the fruited plain seeing investors. It’s fun! And back then, most of the money and the market’s volume came from stock-pickers. You could literally call on more investors and create shareholder value.

That market doesn’t exist anymore. Look once more at the images.  Passive Investment is quantitative. Fast Trading is quantitative investment with a horizon of a day or less, suchy as fractions of seconds. It’s 73% of trading in S&P 500 stocks.

Most of the money isn’t influenced by story. You can keep doing what you always have! But the data show it’s unlikely to produce returns.

Let’s be smarter than that! There are myriad ways for IR professionals to make their c-suites and Boards smarter market participants (ask us!).

And if we’re smarter, maybe we can mount a data campaign to get some of these anachronistic disclosure albatrosses off our backs.

The equity market is a machine full of closet-indexers. Let’s use that data not to stay in 1998, but to our advantage, public companies.

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