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Active or passive: who will own the next Amazon?

Active or passive: who will own the next Amazon?

Amazon marked its 20th anniversary as a public company on 15 May, an occasion that attracted a great deal more attention than the 20th anniversary of another tech firm that reported its first profits in 1997.

That was of course not Amazon, which recorded its first quarterly profit in the final three months of 2001, but Lycos. Lycos now vies with Ask Jeeves as a punch line, but how many investors would have preferred it to Amazon as a stock in 1997?

Even leaving aside the issue of profitability – Lycos remained in the black until its acquisition in 2000 – the choice was between a leading search engine and an online book seller. One had an innovative licensing business model and patent trove; the other was battling lawsuits and competitor sites from established giants like Barnes & Noble.

Jeeves the butler, a precursor to Apple's Siri 

 

In the bubble basket 

If it was difficult for active managers to justify owning Amazon then, it didn’t become any easier through the subsequent two decades. David Einhorn of Greenlight Capital placed it in his ‘bubble basket’ of shorts in 2014, since when the stock has gained over 200%. Short interest hit a record high of more than $5 billion late last year, and naturally Amazon is up by more than 20% since then.

Yet passive investors should not rejoice too loudly, regardless of where Amazon goes from here. For a start, they will also hold the many businesses being crushed by Amazon – not least the rest of the retail sector.

Then there is the fact that the company was not a member of the S&P 500 – the most widely tracked US index – until 2005. While the stock has returned over 2,000% since admission, the delay cost those who only owned the S&P 500 many multiples of that – factoring in stock splits, Amazon has gained more than 55,000% since floating, even though the full period includes the dotcom crash.

 

Snap shares dived this month as its debut earnings missed forecasts

 

Snap decisions

S&P 500 investors should therefore remember that they do not passively hold the entire US market in their portfolio, even allowing for the omission of small and mid-caps. There are plenty of potential Amazons outside their trackers because of the S&P 500’s eligibility rules on profitability and corporate governance.

Snap is a recent example, but other prominent names outside the S&P 500 include Tesla and Alibaba’s US listing. Lots of investors will perhaps be happy to avoid such companies but, as well as making their portfolio more actively constructed than they may realise, they probably wouldn’t have lamented Amazon’s absence at first either.

 

Didn't factor that

Equally, many factor investors will have had limited if any exposure to Amazon’s ascent. It may be captured by momentum and growth methodologies, but despite its power it tends to be ruled out of quality indices, due for example to a few losses in recent years.

Indeed, Lycos may have been the more likely to feature in quality ETFs given its sustained profitability. That would not have been preposterous at the time. A seemingly sound business in a fashionable sector, many Lycos investors did make money: from its initial price of $16, the company’s shares ended up valued at $97.55 when it disappeared into a Telefónica affiliate.

 

All indices are not created equal 

Perhaps nobody expected the Spanish acquisition, just as few predicted Amazon’s shares surging for so long. Holding the entire market is thus likely to be the wisest long-term option, but passive investors should recognise that their chosen index fund – even if it is the most popular one – may only capture a subset of the market and miss any early gains from the next Amazon.

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