Gundlach recommends shorting SPY in new pair trade, says passive investing is a 'myth'

Julia La Roche
Reporter
Jeffrey Gundlach

Bond investor Jeff Gundlach, the founder of DoubleLine Capital, offered an interesting pair trade: short the SPDR S&P 500 ETF (SPY) and go long iShares MSCI Emerging Markets ETF (EEM).

Using Robert Shiller’s Cyclically Adjusted PE ratio (CAPE Ratio), Gundlach argued that emerging markets looked cheap compared to the U.S.

“And what the heck, let’s have some fun and leverage it one time,” he said.

Gundlach made this recommendation on Monday at the Sohn Conference in New York, where he ripped into the passive investment movement.

Passive investing typically involves using exchanged-traded funds (ETFs) or low-cost mutual funds to track broad market indexes like the S&P 500 (^GSPC). Active investing could involve trading stocks, tilting sector weightings, or making various other decisions actively in an attempt to beat benchmarks like the S&P 500.

Due to high costs and poor performance, actively managed funds have seen massive outflows and passively managed funds have seen massive inflows.

At the conference, Gundlach took the stage and pulled up a painting by Max Beckmann entitled “The Night.”

“This is a pretty tough picture,” Gundlach said, adding, “This is a pretty tough world.”

Gundlach, who’s known for his art collection, explained that the artist Beckmann was a medical orderly during the first World War. He described Beckmann as “a painter with an eye wide-open to the rest of the things the world chooses not to see.”

“My name is, ‘Portrait of U.S. Long-Only Equity Managers 2017,’” Gundlach said of the image.

He then pulled up a self-portrait of a confident-looking Beckmann. Gundlach said would call that picture, “Portrait of Equity Index Managers 2017.”

Max Beckmann, 1918-19, The Night (Die Nacht), oil on canvas, 133 x 154 cm, Kunstsammlung Nordrhein-Westfalen, Düsseldorf

“We can see why index managers are feeling so good about themselves,” he said, displaying a chart that showed the tremendous inflows into passive investments from active.

He went on to slam passive investing a “myth” and used German philosopher Friedrich Nietzsche to illustrate some of his points.

Gundlach described a “frenzy” of momentum behavior behind index flows. He views this as the reason there’s been distortions in the market and valuations that have “gotten out of whack with the rest of the world.”

Furthermore, he argued that pension funds are abandoning their fiduciary duty by opting for passive investments.

“In essence, when pension funds are going to passive, so-called passive S&P investing, they’re hiring an unknown committee they have never met, never inquired into processes, never did any due diligence whatsoever. In essence, going institutional into passive S&P manager is abdicating your fiduciary duty.”

As for the fate of active managers, he quoted Mark Twain: “Reports of my death have been greatly exaggerated.”

Julia La Roche is a finance reporter at Yahoo Finance. Follow her on Twitter.

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