Don't let 'bubble' comment distract from Big Short manager's small-cap thesis

Index-investing detractors who’ve latched onto his statement are overlooking his broader point on value-type securities

Don't let 'bubble' comment distract from Big Short manager's small-cap thesis

Last week, famed fund manager Michael Burry, whose bet against mortgage-backed securities prior to the 2008 crisis was immortalized in The Big Short, made headlines with a comment he shared with Bloomberg News.

“The bubble in passive investing through ETFs and index funds as well as the trend to very large size among asset managers has orphaned smaller value-type securities globally,” he said in an email to the news outlet.

Whether he actually thinks that index-based ETFs will have a day of reckoning isn’t clear from the Bloomberg article. Those fixated on headlines highlighting the word “bubble” might come away with that impression; on the other hand, he might have just used the word as shorthand for something that’s popular or overvalued.

But that’s beside the point. Burry’s main argument, it seemed, was that the growing popularity in passive investing has opened a door for active fund managers in smaller, value-type securities. “There is all this opportunity, but so few active managers looking to take advantage,” Burry told Bloomberg News.

That may be hard to believe for those watching the Canadian stock market. As noted in the 2018 SPIVA scorecard for Canadian mutual funds, the S&P/TSX Composite finished the year with an annual loss of -8.89%, which was led by smaller-cap names. Canadian fund managers within the small- and mid-cap equity space underperformed as well, with 80% falling below the -12.85% calendar-year performance of the S&P/TSX Completion Index.

This year, the S&P/TSX Small Cap Index has managed an increase of 4.6%, though it still lags in comparison to the 14% gain in the S&P/TSX. “The market is flashing a warning sign,” Nicolas Piquard, portfolio manager and options strategist at Horizons ETFs, told Bloomberg. “Small cap stocks tend to be riskier than large cap stocks. Since they are smaller, they generally suffer more and have a harder time managing in an economic downturn.”

Read also: Five myths about small cap investing

Canadian investors might be tempted to write off small-cap value stocks, along with active funds that are exposed to them. But Burry, who holds a passion for “long-oriented investing in undervalued and overlooked situations,” offers a way forward: helping companies make themselves more attractive through shareholder activism.

According to Bloomberg, he urged GameStop Corp., a video-game seller, and Tailored Brands Inc., a menswear retailer, to buy back stock in August; the two companies climbed by 7.6% and 4.9%, respectively, last Wednesday. He has also shared his intention to engage with management at Autech, a delivery truck and ambulance maker, of which his firm owns a nearly 10% stake.

Small-cap fund managers may benefit from an engagement strategy, but only if it’s done properly. “I have seen the mistakes Americans make with activism over the years, especially in Asia,” Burry told Bloomberg News. He cited an instinct to offer “friendly advice” in pursuit of a “productive conversation,” though he acknowledged that hostile situations could still arise.

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