Passive investing

Good piece in the FT about Jack Bogle (Vanguard) saying that ETFs and index tracking mutual funds could become 90% of the equity market.  At some point, you must reach “peak passive”, right?

Passive funds, and their long term returns, work because there are active managers pricing stocks.

“There must be some limit somewhere with how much indexing there can be without producing the efficiencies of the market,” Bogle said. “[But] if I had to guess, I’d put [the limit] in the area of 70 or 80 or 90 per cent — very large — because there will always . . . be people looking for values, price discovery and all that kind of thing.”

First, a thought experiment, then we’ll dial it back.  If we got to 100% passive, the stock market wouldn’t move … or maybe would spiral upwards infinitely?  If the market is 100% passive and there is no new money introduced, the market would sit at one price forever.  No individual share of a company is changing hands because all of the shares are owned by Vanguard and BlackRock.  A pension plan needs to invest new money into equities, they invest in ETFs (because that’s the only thing you can do), and what happens?  How does that new money get incorporated?  There are no shares to buy.  The indexer would have to hope that there’s another pension plan that needs to redeem at the same time.

Passive investing is kind of the antithesis of what a market is for.  For any individual investor, it makes the most sense: you don’t know what stocks are going to go up more than others, so diversify away.  On the other hand, how much price discovery is going to happen when only 10% of the market is doing the job a market is supposed to do?

 

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