No wonder passive investment vehicles are so widely popularised in the West. Self-perpetuation of price driving narrative. An increasing number of investors are becoming more comfortable with earnings "average" returns (that of the market).
As the composition of passive investing grows, does the potential alpha of being a (presumably good) stock picker increase or decline?
I think it will soon be a time where we open a debate on how much "passive" an investment in S&P500 or Nasdaq really is as the top 5 companies form over 20% of the index (S&P 500), and over 40% of the Nasdaq.
Passive investing by definition relies on active investors/traders doing price discovery. As share of passive investing grows after a certain point of time, it will be more attractive to draw alpha by individual bets, as there are less market participants doing active stock picking.
I don’t think we are near the stage where passive investing is that big a group that active investing can derive easy alpha yet.
@investmenttalk This is a question that I have pondered on myself, and there is no easy answer.
However, consider a thought experiment. All market players are active investors except 1 person who passively buys the index. The passive investor gains here because they are profiting off active investors price discovery efforts which keeps the markets efficient.
Now consider the inverse of this. All market participants are passive investors except 1 person who actively sets the buy/sell price on individual stocks. As passive investors buy/sell ETFs, underlying stock redemptions will only be bought/sold by the active investor giving them the freedom to manipulate prices to their will.
The thought experiment merely demonstrates what happens at the extreme cases. A real model should probably market participants in a simulation to see at what % of active investors it is still effective to draw alpha. The difficulty is it difficult to simulate market models effectively, but one can probably get some approximation based on some assumptions. I am too lazy to do that. 🥲 My suspicion is the market needs a small % of active investors to be efficient and enable price discovery, as these active investors are playing against each other. However, I have no clue to this exact % amount.
@q2capital That's a great way to frame it. I have been thinking about this most of the morning, or rather its been on my mind.
Stumbled across a new author today, really enjoy their perspective on this topic, you may enjoy it.