Christopher Cole of Artemis Capital Management in Texas, published a research article in July entitled, What is water in the markets?, which has resonated powerfully with the investment community and performed a valuable service in identifying the inherent dangers of passive investing. Cole asserts that the most obvious, ubiquitous, important realities are often the ones that are the hardest to see and discuss. His title came from an apocryphal tale, summarised in Figure 1. His essay foretells a coming volatility storm in which confidence in the entire medium of modern credit creation and the formation of asset prices, from which all measures of financial wealth are derived, is shaken.
The essay spans liquidity, volatility, and passive investing, challenging conventional wisdom at multiple points along the way. He posits a shift in the dominant view from believing that value is independent of the medium and intrinsic to the asset, to believing that the medium (liquidity) is the sole determinant of value, as defined by continuous bid and ask prices. If an asset is only worth what someone is willing to pay for it, and value is ‘created’ by the medium of money, then there is no need to pay someone to find value through active investment management.