Agreed but it is a cost that index replicators must absorb, yet doesn't show up in returns of the funds as the index itself "absorbs" or reflects those costs. The other side benefiting are the front runners like Renaissance Technology and other HFTs who are extracting billions from index replicating funds.
The SPIVA data is hard to argue with — 98% of multi-cap funds underperforming over 10 years is damning. And I agree that the "passive is destroying price discovery" narrative from active managers is largely self-serving. But I think there's a narrower structural argument that your piece doesn't quite address: it's not that passive investing makes markets less efficient in aggregate. It's that the mechanics of how indices rebalance — binary add/drop events forcing billions in same-day execution — create acute distortions at specific moments. Arnott et al. found additions are priced at 4x the valuation multiples of deletions. That's not an efficiency argument. That's a plumbing argument. The market can be broadly efficient and still have a rebalancing framework that was designed for a world that no longer exists.
I have seen research showing that $1 of passive investing has more than $1 of market impact and maybe disproportionate impact on large stocks. But I always felt commentators are hysterical about growth of passive.
I use trend following on my passive allocation anyway. Pacer and Strategy Shares have trend following passive etfs. Interesting products. If passive unwinds or there's drawdowns historically at least trend following saved you.
Another way to look at is if every penny was index in a single giant index fund stock prices would always move in lock step. That is obviously not happening which implies price discovery is happening. The total proportion of active management to support is probably pretty small. My guess is 5%. Another way to frame it how much selling relative to the float is required to significantly move a stock.
Latest research shows that the growth in indexing has significantly reduced liquidity in markets with one new dollar moving prices $5. So more stock volatility
i believe there is one argument that has not been discussed here: if more and more goes into indexing and away from active, the active funds have less firing power against the monolithic indexers...and in addition that smaller budget will be spread across more shares than the indexers.
Agreed but it is a cost that index replicators must absorb, yet doesn't show up in returns of the funds as the index itself "absorbs" or reflects those costs. The other side benefiting are the front runners like Renaissance Technology and other HFTs who are extracting billions from index replicating funds.
The SPIVA data is hard to argue with — 98% of multi-cap funds underperforming over 10 years is damning. And I agree that the "passive is destroying price discovery" narrative from active managers is largely self-serving. But I think there's a narrower structural argument that your piece doesn't quite address: it's not that passive investing makes markets less efficient in aggregate. It's that the mechanics of how indices rebalance — binary add/drop events forcing billions in same-day execution — create acute distortions at specific moments. Arnott et al. found additions are priced at 4x the valuation multiples of deletions. That's not an efficiency argument. That's a plumbing argument. The market can be broadly efficient and still have a rebalancing framework that was designed for a world that no longer exists.
I have seen research showing that $1 of passive investing has more than $1 of market impact and maybe disproportionate impact on large stocks. But I always felt commentators are hysterical about growth of passive.
I use trend following on my passive allocation anyway. Pacer and Strategy Shares have trend following passive etfs. Interesting products. If passive unwinds or there's drawdowns historically at least trend following saved you.
The paper here https://www.nber.org/system/files/working_papers/w28967/w28967.pdf
found that $1 increased flow impacts prices $5
Maybe the increase in retail investors is increasing price discovery outside institutional investors
depends if the trading by retail investors is informed traders or noise traders
Another way to look at is if every penny was index in a single giant index fund stock prices would always move in lock step. That is obviously not happening which implies price discovery is happening. The total proportion of active management to support is probably pretty small. My guess is 5%. Another way to frame it how much selling relative to the float is required to significantly move a stock.
Latest research shows that the growth in indexing has significantly reduced liquidity in markets with one new dollar moving prices $5. So more stock volatility
i believe there is one argument that has not been discussed here: if more and more goes into indexing and away from active, the active funds have less firing power against the monolithic indexers...and in addition that smaller budget will be spread across more shares than the indexers.
So what is the impact of your hypothesis