The shift from Active to Passive Investment - How does it affect market valuations?

L

Laissez Faire

As active funds are losing, and probably will continue to lose, market share to passive funds - how will this affect market valuations?

It's not something I've thought a great deal on, but in simple terms, it seems to me that if there's no longer active funds which can express their opinion on prices by selling (shorting or profit taking) shares, indexation and passive investment will artificially inflate the stock prices of the stocks that are part of that particular index and obviously the index as well. This will probably relate to other asset classes, too.

Pretty much every retail investor I know are buying index funds only and they're buying it monthly for long term investment / retirement accounts regardless of current stock climate. They're buying index funds because historically they outperform active investment.

Some of these are also ready to go all in on the next market drop as stock prices only go up long term according to them. They have no knowledge of stocks or the general economy. Just this basic 'fact' and as such they simply buy. No further thought is involved.

I see there's a new paper from the FED on this which does seem to acknowledge that indexation / passive investing does boost the price of stocks that are included in the index and may cause a bubble.

https://www.federalreserve.gov/econ...ng-potential-risks-to-financial-stability.htm

This article, too, warns against the risks of indexation.

https://www.firstlinks.com.au/paradox-passive-investing

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Good question. I think the biggest impact is a decrease in volatility, which should decrease the estimation error residual, making markets more efficient and reducing the value of "valuation signals" as market prices more accurately reflect fundamentals.
 
The Mr. Market is reinventing the old/existing products or introducing the new ones.
(fractional shares, BTC futures, a garbage that was made out of the garbage, which was made from the garbage & etc.)

Lot's of capital will sunk in those.
Let those valuations to fly into the stars, while puts lands onto the moon.
I mean, if one knows that which he is doing, then that's the last thing to worry about.
If it goes too high, at some point it will go too low.
,,At some point'', might take ,,some'' time.

Meanwhile, plenty of opportunities.
(Last time checked 630 000 equities alone, globally, while a dozen is more than enough)

https://www.elitetrader.com/et/threads/the-rise-fall-of-passive-investing.352624/
 
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Passive funds are the epitome of dumb money. That it will not end well for this generation of true believers is obvious. The timing of the tipping point is less obvious, but it can’t be too far in the future.
 
Snuskpelle said:
Think he's referring to e.g. S&P 500 membership overpricing. It's going to hit passive investors at some point, but until then it seems like a great idea and equally is one of the world's most crowded trades.
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Yes, i view it like this as well, yet, thought, maybe a man has some different reasoning.
(being open minded, new scenarios etc.)
Thanks for reply.
 
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