We recently published a list of The 10 best asset management stocks to buy according to short sellers. In this article, we take a look at how Fidus Investment Corporation (NASDAQ:FDUS) compares to other asset management stocks.
At the market level, investing can be divided into two categories: active investing and passive investing. Active investing, as the name suggests, is a practical approach in which the investment manager or the ordinary investor regularly evaluates his portfolio to reduce or increase shares depending on the evolution of the individual capital and the general market trend. Passive investing, on the other hand, means that the individual investor or a fund manager buys shares and then holds them with all his might over a long period of time in order to replicate the evolution of a broader stock index, rather than focusing on the merits of individual stocks.
Comparing the two approaches, passive investing requires less focus. Of course, it’s not surprising that this approach has dominated the market for the past few years. Data from Morningstar Financial shows that year-end 2023 was historic for the stock market, as assets held by all passive funds exceeded those held by active funds for the first time. At year-end, passive mutual funds held $13.29 trillion in assets, which was $60 billion more than active funds’ $13.26 trillion in assets. This shift appears to be driven by the tendency of passive funds to outperform active funds over the long term. According to S&P, over 90% of active equity funds underperformed their underlying benchmark over the past two decades.
However, this shift does not seem to affect all active fund categories. Morningstar data adds that there is a stark contrast between active exchange-traded funds (ETFs) and active mutual funds. When analyzing the net inflows into these two categories between 2008 and 2023, it is seen that inflows into the mutual funds increased significantly until 2014, but the trend reversed somewhat after that. In the years between 2015 and 2023, only 2021 was the year with positive inflows into active mutual funds, as about $150 million of funds flowed into them. In all other years, all inflows were negative, with 2022 being the worst year, which saw about $1 billion in outflows. On the other hand, the inflows for the actively managed ETFs were positive in all these years, recording an average growth of 37% in the decade to 2023.
Although passive funds have outperformed active funds in terms of total assets, there are still a number of active funds that have performed well during this turbulent period. The three active fund categories that have delivered robust returns recently are fixed income funds, real estate funds and small-cap funds. Active fixed income funds had a 53% success rate in 2023, and it is real estate funds where active funds really shine. In the decade to 2023, 51% of active real estate funds outperformed their passive counterparts, making them the only funds to do so during this period. Finally, fund managers benefited from their expertise and resources, as 41% of active small-cap funds beat passive funds and their excess returns exceeded 16%.
While the growth in passive funds indicates a democratization of the stock market as these funds are favored by retail investors, it also leads to some undesirable consequences. For example, a 2019 study by the Federal Reserve shows that passive ETFs and mutual funds from the five largest asset managers had $7.7 trillion in assets under management as of December 2019. This represented 47% of all such funds, with Vanguard in particular accounting for 25% of the pie.
Research from Harvard and Columbia provides further insight, particularly regarding the control that the largest asset managers can exert on the stock market. Harvard estimates that the three largest index fund managers, namely BlackRock, Vanguard and State Street, held an average stake of 22% in the companies in the benchmark S&P index in 2021, which corresponds to 25% of the votes cast in these companies. Columbia adds that in 90% of these 500 companies, one of the Big Three is not only a shareholder but also the largest Shareholder.
Another consequence of the shift to passive investing is the impact on the valuation of large-cap stocks. According to Man Group, $2 out of every $3 of large-cap stocks comes from passive investing. As we saw with the artificial intelligence boom, stocks of major technology companies have driven up stock market valuations, and research from the London School of Economics and the University of Michigan provides further details on the growth of passive investing and its impact on the valuation of large-cap stocks. They show “that inflows into passive funds disproportionately increase the share prices of the largest companies in the economy, particularly those large companies that are overvalued by the market,” adding that these inflows “can drive the overall market higher, even when the inflows are entirely due to investors switching from active to passive investments.”
These recent trends have also hit small-cap stocks pretty hard. According to Morningstar’s Dave Sekera, small-cap stocks are “actually trading at about a 20% discount to our fair value, so there’s a lot of value there. So I think once we get past, you know, a lot of the thematic trading that’s really driven the market over the last year and a half, the market will start to become more of a stock picker’s market again, which I think we need to see for the market to continue its gains. But I think stock pickers, especially in the small-cap space, have a long way to go.”
Our methodology
To create our list of the best asset management stocks to buy according to short sellers, we ranked these stocks by their short interest as a percentage of shares outstanding, selecting the stocks with the lowest percentage and a market cap of over $600 million to eliminate the impact of low liquidity.
With these stocks, we also mentioned the number of hedge fund investors. Why do we care about the stocks that hedge funds invest in? The reason is simple: Our research has shown that we can outperform the market by mimicking the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks each quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points (Further details can be found here).
A close-up of a contract signing showing a transaction for mezzanine, growth capital and debt investments.
Fidus Investment Corporation (NASDAQ:FDUS)
Number of hedge fund investors in Q2 2024: 3
Short Interest % of outstanding shares: 0.44
Fidus Investment Corporation (NASDAQ:FDUS) is a class of asset management firms called business development companies. It uses a variety of investment tools such as loans, private equity, acquisitions, and others to run its business. Fidus Investment Corporation (NASDAQ:FDUS)’s business is divided into income from debt issued and equity investments made. This means that even if the stock markets struggle in a high-interest environment, the company can make up some of the shortfall through higher interest income from its debt portfolio. However, higher interest rates also mean that Fidus Investment Corporation (NASDAQ:FDUS) needs to regularly monitor its debt portfolio to be adequately protected against unexpected defaults. In addition, in a weak economy, the number of deals it can finance through equity also decreases, and of the remaining ones, Fidus Investment Corporation (NASDAQ:FDUS) needs to carefully analyze the opportunities.
Management of Fidus Investment Corporation (NASDAQ:FDUS) shared its near-term outlook during the second quarter 2024 earnings call and commented:
“As for our outlook, we continue to expect deal flow and M&A activity to remain at reasonable levels for the remainder of the year.
While we expect increased investment activity, we also expect a pick-up and redemption as numerous portfolio companies evaluate strategic alternatives. We continue to focus on opportunities that meet our rigorous underwriting standards, leveraging our relationships with contract sponsors and our lower middle market industry expertise. We continue to invest in companies with strong and sustainable cash flow generating business models and positive long-term prospects. At the same time, we continue to structure our debt investments with a high equity buffer and maintain a portfolio that offers both high current and recurring income and the potential for higher returns from the monetization of equity and securities.”
General FDUS ranks 10th on our list of the best asset management stocks to buy according to short sellers. While we recognize the potential of FDUS as an investment, we believe AI stocks promise higher returns and do so in a shorter time frame. If you are looking for an AI stock that is more promising than FDUS but trades at less than 5 times its earnings, read our report on the cheapest AI stock.
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Disclosure: None. This article was originally published on Insider Monkey.
