Vanguard now owns more shares in MicroStrategy than its founder Michael Saylor despite publicly dismissing crypto as speculative. The irony is hard to miss, but the real lesson is that so-called passive investing is becoming anything but passive.
MicroStrategy, which rebranded as Strategy in February, has hit on something ingenious: in a world dominated by index investing, it is no longer about profit or revenue, but about index weight. By artificially inflating its market capitalization through bitcoin purchases, the company buys itself a place in major indices. That forces passive investors worldwide to buy its shares, whether or not they have any interest in bitcoin.
It is a brilliant hack of the system. Why bother improving your business model if you can simply manipulate the index? Strategy is no longer a software company; it is a bitcoin lever financing itself by becoming part of every pension portfolio. The company is pulling itself up by its own bootstraps, and bitcoin is slipping effortlessly into the financial system.
And it is not alone. More and more companies are discovering the same loophole. By pumping up their market cap, via bitcoin or other financial tricks, they literally buy themselves a place in the portfolios of millions of investors. The result is that index investing becomes forced active investing, but without the benefits of real active decision-making.
The myth of passivity
Index investing was never truly passive. Every index is the result of active choices: which companies are in, which are out, and how they are weighted. Take defense stocks. For years, investing in controversial weapons such as cluster bombs and landmines was excluded by the Dutch government under international treaties, a deliberate active choice. But since the war in Ukraine, defense companies are suddenly back in favor. Not because they have become better companies, but because political winds have shifted. Regulation, tax policy and subsidies increasingly determine index composition.
Mergers and acquisitions are also influenced by index weight. Companies not included in any index trade at lower valuations, while those with a heavy index weight are instantly catapulted to the top of a sector, attracting even active managers who track index trends. Index investing thus contributes to the creation of monopolies and oligopolies. That may benefit investors, but it is not healthy for a free market.
Free float
Then there is the matter of free float. Index providers decide which shares are considered freely tradable. The stake of Charlene de Carvalho-Heineken in Heineken is excluded because she is a major shareholder; those shares do not count toward index weight. Logical, you might think, since they are not freely tradable.
But look at bond indices. Government bonds purchased by central banks are fully included, even though they are just as unavailable for trading. Central banks now hold trillions in sovereign debt, and it all still counts in bond indices. Why the difference between bonds and equities? Because index providers say so.
Or consider ESG index investing, which markets itself as passive sustainable. In reality, every ESG index is shaped by hundreds of active decisions about what counts as sustainable. Tesla yes, ExxonMobil no. Why? Because a committee decided so, not because the market did.
The downside of success
Index investing’s success has created a monster. With more than 10 trillion dollars under management, Vanguard, together with Blackrock and State Street, decides who wins and loses in the corporate world. Not based on performance, but on index rules written by a handful of people.
Companies are adapting. Why innovate if you can game the index? Why keep customers happy if you can buy weight in the S&P 500? The system rewards financial engineering over genuine value creation.
The great reset
We are heading for a reckoning. Index investing in its current form cannot survive if more companies exploit the system. The choices are limited: either indices become explicitly active, with all the costs that entails, or we accept that so-called passive investing means funding every financial gimmick that comes along.
The Vanguard–MicroStrategy story is just the beginning. Soon, we will wonder how we ever believed that buying the whole market was a neutral choice. Every index is political, every weighting is a decision, and every exclusion is a statement. Passive investing is dead. Long live active investing, even if we still call it passive.
Han Dieperink is chief investment officer at Auréus Wealth Management. Earlier in his career, he served as CIO of Rabobank and Schretlen & Co.