Acquired
03:17:10 · David Rosenthal, Ben Gilbert
[03:17:10] S1: So, Jack, yes. [03:17:11] S0: I don't think corporate structure and corporate governance has ever played such an important role as it did on this one. Yep. I was racking my brain on you know, we we always talk about these founder led companies or or private family ownership lets you take a longer view, but this is something else entirely where it was literally path dependent. The only reason that they had the market opportunity that they had was because of the corporate structure that they had. Yep. Be fun to see if there's other ones of those that exist. [03:17:39] S1: Yep. [03:17:40] S0: Alright. Should we get into the criticisms of passive investing as a movement? [03:17:45] S1: Yes. The crisis. We would be remiss if we don't [03:17:49] S0: The crisis. Of course. [03:17:50] S1: The passive crisis. [03:17:51] S0: What is once a revolution becomes a crisis, if you, let it become successful enough. [03:17:56] S1: Yeah. And this is what we were alluding to earlier with, like, hey. If one of these companies were to go down, it would be systemically really bad. Also, flip of that is these large index fund complexes of which Vanguard is the largest control a huge percentage of the voting shares of all American corporations and increasingly all corporations around the world. [03:18:18] S0: Yeah. So first of all, there's this name, passive investing. That's not true. It's not like an algorithm determines what is in the S and P 500. It's a committee of humans. [03:18:33] S1: Mhmm.
03:18:33 · David Rosenthal, Ben Gilbert
[03:18:33] S1: Mhmm. [03:18:34] S0: So this whole thing is predicated on just, you know, owning that basket of stocks. But the S and P 500, yeah, it's got some rules, but it's not entirely rules based. Those just are govern what companies are eligible to get voted in by a small group of people around the table. [03:18:51] S1: Who you might say are Actively the fund advisers, the investment advisers to the majority of, you know, the American public here. [03:18:59] S0: Yes. The counterargument to this is that only matters in the short run. In the long run, the S and P 500 returns are almost exactly the same as the total market returns. So it doesn't keep me up at night, but I always think it is a little bit funny of, like, it's not totally passive. [03:19:12] S1: Yep. [03:19:12] S0: Okay. So other criticisms here of the indexing. Unlike businesses that have some form of physical operations or, like, an addressable market being small that constrains it, asset management can scale infinitely. Like, its market is investing literally any currency in literally any company, which is the TAM for that is like all of humanity. It's it's all of humanity's wealth. [03:19:39] S1: So Market size unconstrained.
03:19:39 · David Rosenthal, Ben Gilbert
[03:19:39] S1: So Market size unconstrained. [03:19:41] S0: It is truly market size unconstrained. You know, think of the largest markets in the world, transportation, housing. This is maybe bigger than any of that. It's a little bit of a crazy thought exercise. So it's not constrained by addressable market. It's it just scales so elegantly other than customer service. It it just doesn't require any additional dollars of cost to serve additional customers and additional revenue. So in theory, a few index funds should continue unabated to scale and own basically everything. [03:20:17] S1: Yep. And we're well on our way to that happening. [03:20:20] S0: Yeah. So here's the stats on it. Thirty five years ago, only 1% of the market was passive. It's now more than 20% of the S and P 500. And a couple of years ago, passive assets in funds overtook active assets in funds for the first time. That that just happened where passive funds eclipsed active funds. So the concern that people have is a few fold based on this. One is there's not enough active traders in the market to accurately discover price. If we're all trusting that the index is gonna buy things at the correct price, you do need active managers to buy and sell to set the price. [03:20:58] S1: Yeah. And the associated criticism of passive, which I think Jack would readily acknowledge is, hey. We're free riders here. Right. We're getting all of that price discovery and price information that the active guys are doing just for free.
03:20:58 · David Rosenthal, Ben Gilbert
[03:20:58] S1: Yeah. And the associated criticism of passive, which I think Jack would readily acknowledge is, hey. We're free riders here. Right. We're getting all of that price discovery and price information that the active guys are doing just for free. [03:21:11] S0: I don't buy this argument. Like, I'm I'm not concerned in any way about this. I think if you had 95% passive, the prices are set by the marginal trader. Right. You don't need very many people in there arguing with their dollars about what something is worth to figure out what it's worth. [03:21:29] S1: Yep. And the profit opportunity from arbitraging Right. Is so great, and that profit opportunity becomes greater as this problem, quote, unquote, gets worse. So, like, the right market balance will figure itself [03:21:44] S0: out here. There is an equilibrium. Long before we get to that problem, you'll have arbitragers that are interested in trading because it's profitable that you're right. It'll hit an equilibrium. At least that's my my perspective on this. The other concern is, well, all these companies now have the same shareholders. Apple, Microsoft, Google, it's all 20% plus. These big [03:22:05] S1: Vanguard, Fidelity, BlackRock, State
03:22:05 · David Rosenthal, Ben Gilbert
[03:22:05] S1: Vanguard, Fidelity, BlackRock, State [03:22:06] S0: Street, etcetera. So why would they compete if, let's say, that 20% goes to 50% or 80%? Shouldn't the owners go tell the CEOs, hey. You guys should just collude and keep prices high. Let's reap in the corporate profits. Let's screw over the American public, the customers, and let's all just make a lot of money together. This also seems a bit far fetched. Right. It it sounds provable in an academic thesis, and then you, like, get actually out in the real world and you talk to some CEOs. Do you think the CEO of any company is is gonna stop competing with their biggest competitor in a fierce battle because an index fund manager [03:22:46] S1: common ownership in index funds? No. [03:22:48] S0: There's just no way. [03:22:49] S1: Yeah. I do think the more legitimate concern version of this is voting and and Yes. Shareholding and, like, sort of being being active shareholders and holding management to account.
03:22:49 · David Rosenthal, Ben Gilbert
[03:22:49] S1: Yeah. I do think the more legitimate concern version of this is voting and and Yes. Shareholding and, like, sort of being being active shareholders and holding management to account. [03:23:02] S0: And right now, it's actually pretty interesting. The way that each of these companies and each of these funds handles how to vote the shares of the index funds is all over the board. Some of them literally let individual index holders vote on individual issues. That's incredibly rare. Usually, what they say is, I wanna pick one of these five options and vote with management, with the majority, with a set of ESG guidelines, and you can kinda that that's the common thing. Most of the times, it's suggestions of how should we vote the shares. But I get where you're going that the fund manager of, let's say, one of these Vanguard or BlackRock grows to be, I don't know, 60% ownership of every company in America. Suddenly, they have voting control over those companies, and it's a big responsibility to decide how they're gonna vote those. [03:23:50] S1: Right. Or or in aggregate, you know, a set of three or four of these large index funds and then their fund holder base, which is the American public. It's like we've turned the board of directors of every company into an election on the order of, like, a, you know, US political election. [03:24:09] S0: That's funny. It turns every corporate governance issue into the court of public opinion. Yeah. Like, how does the American public feel about this?