Conor Mac's avatar
$341.8m follower assets
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?

Rihard Jarc's avatar
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.
Conor Mac's avatar
@rihardjarc Not sure about the Nasdaq, but has there not always been the case where the top 5-10 companies control a sizeable chunk of the overall index?
Rihard Jarc's avatar
@investmenttalk Not sure really. Never checked the historic weights of the S&P 500 top 5 stocks in the 1990 or 1970, but would be interesting to see.
Q2 Capital's avatar
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.
Conor Mac's avatar
@q2capital interesting, thanks for your take there. Hypothetically, what kinda level do you think it would need to be?
Q2 Capital's avatar
@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.
Conor Mac's avatar
@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.

Q2 Capital's avatar
@investmenttalk thanks for sharing! The article looks interesting, will read.
Sachiv's avatar
Is this chart $ adjusted? Or local currency performance?
Conor Mac's avatar
@passiveinvestor I believe they are all just quoted prices in their own currency, the historical price line.
Uday's avatar
How does this chart fit into the passive-active debate?

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