Penalizing Principals

Estimated Reading Time: 8 minutes

This article is a deeper dive into one of the themes we introduced in our white paper this past summer. To read Owners Vs. Agents, please click here for access at the International Review of Financial Analysis.

Chasing Billionaires

“Have your money where the owners are.” –Mario Gabelli

Early in the days of GreenWood, as I was starting to divert more time away from the American capital markets, a friend in Europe told me when he goes into a new country, he likes to look at who the billionaires are in that country, and studies both how they did it and whether he can co-invest along-side them.

In most markets, you can co-invest with these incredible founding value creators, well after they’ve scaled their businesses. Sometimes they’ve stalled out, or redirected energy and resources elsewhere. But most of the time, they remain committed investors and chairmen or board members of the babies that they built. They bring a “whatever it takes” philosophy to the board that is missing in most independent boards.

Copying this simple principle will align your capital along-side the principals who are the notable value creators in every country. These are people that often have the most to lose if the company veers off track — but also the most to gain when the company seizes the opportunities in front of them.

With many foreign markets not as capital friendly as the US market’s, often as the result of tougher regulatory and legal requirements, aligning oneself with a local billionaire has major advantages. These local hurdles often create moats for the incumbents that make them even more attractive businesses to invest in. Yet they simultaneously make these markets more dangerous for outsiders. Partnering with a local billionaire, nearly by definition, will ensure that your underlying capital is co-invested with someone who knows how to navigate these complex and often bureaucratic processes in the fastest and most proper manner.

But even more than the legal and regulatory considerations — the real advantage, that we believe cannot be overstated, is that these board members and managers have material skin the game. There is no better alignment between counterparties than all of them staking real material wealth on a venture. Just as we have coinvested nearly all of our capital into our own funds, we like to only back managers that are willing to co-invest material capital amounts alongside us in their businesses.

Unfortunately for most investors around the world, the use of passive indexes, advisors and consultants systematically disadvantages the people who have been most capable of creating enormous sums of value. I touched on this in my white paper that was published this past summer in the international Review of Financial Analysis, but the problem is worth more analysis to understand possible solutions.

The Hidden Index Bias

“The problem with experts is that they often lack skin in the game.” —Nassim Nicholas Taleb

Because most market indices, especially the most popular ones, systematically disadvantage companies where insiders, founders or controlling managers still own a sizable portion of the shares, these companies are often either under-weighted in the index, or are completely missing.

Furthermore, in the overall indexes, inside ownership is worryingly declining even further. Figure 3 from the White Paper highlighted this troubling trend.

Exhibit 1: Average S&P 500 Insider Ownership

Source: Owners vs. Agents

We also broke up S&P constituent performance by inside ownership quintiles to show a direct and meaningful correlation within the index of inside ownership — increasingly a rare finding within this index.

Exhibit 2: S&P 500 Performance by Quintile of Insider Ownership

Source: Owners vs. Agents

Figure 24 of the white paper further broke down the shareholder bases of the index vs. the owner data set, and the results were stark — institutional exposure to the ownership asset class was as little as half of that to the index.

Exhibit 3: Institutional Investor Exposure to Owners vs. the Index

Source: Owners vs. Agents

Index regulatory boards will qualitatively penalize companies for lower liquidity, a lower float, and lower institutional ownership, creative a negative feedback loop for passive investors that want to break away from the herd.

Perhaps breaking away from the herd has never been more important with the index concentrating on a small group of the most expensive companies. Nvidia is a staggering 7.5% of the S&P 500 right now.

Nvidia is caught in a circular reference shell game, where it must invest greater and greater sums into its customers for them to afford submitting more orders on top of the unprecedented commitments and order book it sports. It’s only a matter of time until this Ponzi scheme unwinds. The leading companies that are participating in this AI frenzy represent an incredible 41% of the S&P 500 index.

For pure passive investors — is that really where you want 41% of your net worth invested?

Further Analysis

“Mimicking the herd invites regression to the mean.” —Charlie Munger

We thought this trend merited further investigation to understand how much these passive flows are missing the boat, and we discovered some surprising answers.

According to CapIQ’s screens, there are 268 qualifying companies headquartered and listed in the US that meet the S&P 500 inclusion criteria, yet are completely left out for liquidity and float reasons.

On average, these companies have double the inside ownership as the S&P 500, 5.8% vs. 2.4% in the S&P 500 as of October 2025. They grow revenue faster, and are cheaper (based on sales) than the indices. While they are slightly more expensive than the median S&P 500 on earnings, we believe this is more than explained by the faster growth rate, and lower EBIT margin — confirming the exact same observation we saw in the white paper in the Owners vs. Agents. Higher growth, lower margins.

Exhibit 4: Key Stats for S&P 500 vs. Missing 268

Data source: CapIQ. Returns calculated from 1/1/15-12/31/24 for 10Y, and 1/1/20-12/31/24 for 5Y

Thus, while indexing and passive investing can seem more efficient and intelligent on paper — in practice, these investors are getting robbed of exposure to the most compelling value creators around the world. They are growing faster and have their incentives directly linked to the other shareholders of the company.

The penalization of these principals is a major opportunity cost for passive investors.

A Major Opportunity Cost

“The sillier the market’s behavior, the greater the opportunity for the business-like investor.” — Benjamin Graham

Of course, many index funds are lower cost than actively managed funds. That’s true in many cases (though not in all — especially in focused ETFs). They also have tax advantages, not incurring realized gains through the holding period, and instead getting a simple capital gains tax at the end.

Index funds make a lot of sense… on paper. They have captured the hearts and minds of the best and brightest.

I recall a Berkshire Hathaway annual meeting where Warren Buffett asked Jack Bogle, the founder of Vanguard, to stand up and receive a standing ovation for his work to combat the high fees of the investment management industry.

Yet, even Jack’s funds — relying on the index advisors at Standard & Poor’s — systematically disadvantaged their own investors for decades by not including Berkshire Hathaway in their flagship funds. Vanguard’s S&P 500 ETF (VOO) is its largest fund, and it is also the largest ETF in the world with over $700 billion of assets under management.

Yet until Berkshire Hathaway was added to the S&P 500 index in 2010, investors in any S&P index fund missed out on material gains. Using only market cap criteria, ignoring the high stock price or the less significant float, Berkshire would have qualified for index inclusion in the 1970s. So, the index administrators were four decades late to waking up.

Today Berkshire is just under 2% of the S&P 500 (1.78% to be exact). Yet, since 1970, it has outperformed the S&P by a staggering 3,872,000%. Assuming a mere 0.2% weight for Berkshire in the S&P 500 over the course of the four missing decades, had the index not penalized Berkshire for Warren maintaining his ownership in the firm, the S&P 500 would be 103% higher today than it is.

And that is for a 0.2% average weight.

Using a 1% weight over the course of the missing decades would yield an index >6x higher than today’s levels.

While Berkshire is surely a positive outlier — I find it staggering that simply not including 1 of the over 200 companies trading on US exchanges, that would have otherwise qualified for index inclusion, leaves more than half of the returns missing.

While I also joined the Jack Bogle standing ovation, and he deserved it, we should have simultaneously thrown rotten tomatoes at anyone from the S&P organization that robbed global investors of a key principal in the Owner group of stocks, which has trounced the S&P 1200 over the past few decades (see the white paper for more details).

What I also find poetic about the Berkshire example, is that since it was included in the index, it has underperformed the S&P 500. This serendipitously is one further example of prior research by Chan, et. al (2013) that shows index additions systematically under-perform the index after inclusion, while index deletions outperform the index.

So poetic.

A Way Forward

“Following what everyone else is doing is rarely a way to get rich.” —Jim Rogers

As of today, we have been unable to find any ETFs or passive investment funds that systematically include owner operators to the exclusion of others. There are multiple ETFs that will focus their portfolios on companies where insiders have been actively buying shares recently, but that unfairly penalizes companies where a founder, entrepreneur or CEO already has their entire net worth invested in the company.

Accordingly, there is no passive fund strategy that will expose investors systematically to the Owner asset class. Perhaps it’s because of the “birds of a feather” phenomenon, but most active fund managers we are friends with have an ownership tilt in their selection criteria. And even more are actively avoiding the index’s exposure to the AI Ponzi scheme.

Because the niche ETFs that focus on specific tilts often have expense ratios that approach 1.0% per year, there is typically no fee disadvantage that comes from tilting your capital towards lower-fee actively managed funds.

A very successful private wealth manager in Dallas recently told me that he’s seeing more highly qualified investors move towards passive S&P 500 ETFs – a true sign of a “top,” in his opinion.

With the herd chasing the performance fueled by a highly vulnerable circular reference, perhaps it’s time to consider exiting the over-crowded indices that are increasingly run by agents. Perhaps it’s time to stop penalizing principals by selecting a handful of owner-operator stocks that will be there to take advantage. Or perhaps, it’s time to consider an actively managed fund that aligns with these principles and principals. The fees are no longer the issue. And remember, there will be no tax advantage if you’re deep in the red on your “set it and forget it,” strategy.

Disclaimer:

This article has been distributed for informational purposes only. Neither the information nor any opinions expressed constitute a recommendation to buy or sell the securities or assets mentioned, or to invest in any investment product or strategy related to such securities or assets. It is not intended to provide personal investment advice, and it does not take into account the specific investment objectives, financial situation or particular needs of any person or entity that may receive this article. Persons reading this article should seek professional financial advice regarding the appropriateness of investing in any securities or assets discussed in this article. The author’s opinions are subject to change without notice. Forecasts, estimates, and certain information contained herein are based upon proprietary research, and the information used in such process was obtained from publicly available sources. Information contained herein has been obtained from sources believed to be reliable, but such reliability is not guaranteed. Investment accounts managed by GreenWood Investors LLC and its affiliates may have a position in the securities or assets discussed in this article. GreenWood Investors LLC may re-evaluate its holdings in such positions and sell or cover certain positions without notice. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of GreenWood Investors LLC.

Past performance is no guarantee of future results.