Passive Flows Decouple Price from Fundamentals
These events highlight a critical issue: passive index fund flows can significantly disconnect stock prices from their underlying fundamentals. Briscoes' 45% rise wasn't driven by improved earnings or business outlook, but by a temporary imbalance in supply and demand due purely to passive fund activity.

If I squint my eyes and focus really hard, maybe I can see some fundamentals. The rise in the Briscoes market capitalisation over time (one of the criteria for inclusion in the index) could be a sign of a larger, more sustainable and less volatile business. Those traits could lead to a lower cost of capital and a higher share price. Maybe more analysts will cover the stock and liquidity will increase, that might lead to a more appropriate assessment of risk and growth prospects. 

I can assure you the passive investors haven’t done that work – and some likely don’t really care what Briscoes actually does. They just buy at any price, and hope the active managers are pricing the risks correctly. Active investors might have formed a view that WHS was in trouble years ago and sold out, the passive investor waited to be kicked out.

This surge occurred despite a challenging domestic retail environment for Briscoes, with group sales declining 2.6% in the first quarter and the flagship Briscoes brand specifically down 4.7%. Ongoing margin pressures across New Zealand's retail industry would typically suggest subdued stock performance—not the sharp revaluation Briscoes experienced.

Historical parallels exist internationally. In the 1990s, additions to the U.S. S&P 500 index typically prompted 7% stock price increases. But today, such effects are largely arbitraged away, with S&P 500 additions in the last decade averaging only a 0.3% bump. By contrast, smaller, less liquid, and less heavily analysed markets like New Zealand remain susceptible to exaggerated swings driven by passive flows, given fewer active investors and limited liquidity.

Alpha Opportunities for Active Investors
While passive-driven volatility can create challenges, it also offers opportunities for active investors to generate alpha—excess returns above the benchmark. In New Zealand, pronounced index-driven distortions can be exploited through several strategies:
•    Anticipating Index Changes:
Proactive investors can buy stocks likely to be included in an index or short those at risk of removal before a rebalance event. Those who anticipated Briscoes’ inclusion could have profited substantially from the stock’s 45% rally.
•    Contrarian Trades Post-Rebalance:
Once passive flows fade, active investors can buy fundamentally sound stocks depressed by forced selling or sell overpriced stocks elevated by forced buying. Warehouse’s sharp drop, for instance, may have presented a value-buying opportunity, while investors who sold Briscoes near its peak benefited when its price later corrected by about 13.7%.
•    Focusing on Fundamentals:
Given occasional mispricing’s from passive flows, active managers emphasizing intrinsic valuations can consistently identify mispriced securities. This careful analysis can generate strong performance in less-efficient smaller markets.

Evidence of Active Outperformance in New Zealand
Encouragingly, New Zealand's active fund managers have historically capitalized on these inefficiencies, consistently outperforming the NZX benchmark. Below is a recent snapshot of this success:

NZ Fund Performance vs. Benchmark

(3-Year Benchmark Return: 5.91%, 5-Year Benchmark Return: 2.71%)


Source: MJW Investment Survey June 2025

All NZ active funds beat the NZX benchmark over five years, with only one missing over three years, clearly demonstrating their ability to exploit mispricing.

NZ vs. Global Markets
New Zealand’s market structure, characterized by limited analyst coverage and smaller overall size, amplifies sensitivity to technical flows like index rebalancing. While this sensitivity can cause short-term distortions, it also creates conditions ripe for active management to thrive. Unlike larger international markets saturated with active analysts and liquidity, New Zealand’s environment allows discerning investors to consistently generate excess returns by identifying intrinsic value and trading around passive index flows. 

Briscoes’ inclusion in the NZX50 highlights persistent one simple market inefficiency in the New Zealand market, which creates opportunities that active managers can exploit over an extended period. The results seen in the five-year track record of active managers indicates there are many more.