By Ruan Jooste, editor of Citywire South Africa.
Original Article: Read Here
The fund manager said index flows, especially into AI megacaps, had made markets less anchored to fundamentals.
Passive investing has changed the way markets behave, making share prices more likely to overshoot when index flows, retail investors and momentum strategies all move in the same direction, according to Centaur Asset Management.
Laing Walker, assistant portfolio manager and global analyst at Centaur, said during the firm’s July investment update that AI had dominated offshore markets this year. The AI infrastructure trade had allowed investors to look past the Iran war, the oil shock, and the risk of higher inflation.
The result was a narrow market. Walker (pictured above) said the S&P 500 index was up 10% year to date, but that returns had been driven by a small basket of AI infrastructure stocks that were up more than 40%. The average US stock was up around 5%.
The AI discussion led to a wider point about market structure. Walker said AI had been the ‘match’, but the ‘fuel’ had come from changes in market mechanics.
‘This has really been driven by passive,’ he said.
Walker said passive investing had grown from about 5% of US equity fund assets 30 years ago to an estimated 60%. That had changed the way prices moved.
‘Markets used to behave like clocks,’ he said. ‘News and fundamentals would drive the price towards fair value.’
Markets now behaved more like a flock, where one move followed another. In Walker’s view, this has created a more momentum-driven and price-insensitive market.
He described a cycle that could start with a normal company result. A business could beat earnings expectations by 5%, and the share price could rise by the same amount. Retail investors could then buy into the move; momentum funds could follow; the stock’s index weight could increase, and passive funds would have to buy more.
As the share price rose, analysts could lift their estimates or price targets, adding further support to the move. A share that should have risen 5% on the fundamentals could end up moving 20% or 30%.
‘You get this very strong multiplier effect,’ Walker said.
Index chasing
That is the practical problem for valuation-based investors. Passive funds do not buy more of a stock because it is cheap. They buy more when it becomes a larger part of the index. A higher share price can therefore create more demand for the same share.
Walker used Tesla’s inclusion in the S&P 500 as an example. He said the share rose more than 100% over about two months around the announcement, without a change in business fundamentals. The move reflected the market’s anticipation of index flows and a large rebalance.
He also cited retail investor buying, leveraged semiconductor ETFs and narrative-driven trades as forces that could magnify market moves. In semiconductor shares, Walker said leveraged ETFs could turn $1 of capital into a $5 share price move.
The same mechanics could work in reverse. Walker said the Hang Seng Tech index had peaked last year without clear news flow, but the cycle was already in motion as capital moved from China technology shares into Asian semiconductor shares. Index weights changed, passive selling followed, retail investors joined the move, and momentum funds used it as a short trade.
Walker kept the argument anchored in earnings.
‘Fundamentals always drive shares,’ he said.
The change was the route share prices could take before fundamentals mattered again. Walker said investors had to expect wider swings, because shares were overshooting on the way up and on the way down.
Centaur had adjusted its execution to that market. Walker said the firm had waited longer before buying some shares, allowed some winners more room and moved faster when flows were working against a holding.
Nick de Vos, a portfolio manager and senior analyst at Centaur, made a similar point about the South African market. He said there was a period in 2025 when precious metals rose while the rest of the market faded. Precious metals were absorbing capital, and managers who wanted to chase that momentum had to sell something else.
That trade had since reversed, helping Centaur’s relative performance. De Vos (pictured below) said the firm has not altered its process significantly.
‘We haven’t changed anything materially,’ he said. ‘We’ve just kept on doing what we do.’