Thanks for this comment Remarkl. I hope you don't mind this long-ish reply. It's just a very good point and I want to give it the attention it deserves.

The degree to which index investing impacts market efficiency can probably fill a book. It's pretty easy to find articles for or against the point, so I won't entertain that debate here.

You write that index investors do none of the work in causing prices to be where they are, but later criticize index investors for price distortion (I guess by mis-allocating capital, which is the usual critique). I imagine you mean to say that index investors do none of the work in bringing prices to their fair value?

Putting aside for the moment the best way to predict fair value--another topic that can fill an entire book--I think it's important to remember that neither active investors nor index investors trade stocks to make markets efficient.

(If that was the case, then bubbles would never get as large as they do).

Rather, investors trade stocks to make a profit.

Active investors are more than happy to play into a bubble if it means that they will profit from it.

The same goes for index investors.

That is, until businesses fail and both investors realize that their assets are over-priced (indices that track the video game industry look alright now,'m not too optimistic).

Where does this leave us? Clearly, index investing is here to stay. The abysmal track record of actively managed funds (which I discuss in other articles) means that fewer investors--young investors, especially--will trust their money with actively managed funds.

That said, I don't think active investing will disappear completely. So long as arbitrage opportunities exist, active investing will flourish--and rightly so!

Instead, I think we'll see two things happen.

First, I think what we'll see is more types of index funds. While I prefer market-based funds (such as XEQT), I see many investors going towards sectoral funds (like the biotech fund you mention), earnings-based funds, dividend funds, leveraged funds, and funds that are some parts passive and other parts active.

Second, we'll see more investors invest passively (in terms of buying index ETFs and holding for the long term) AND actively (in terms of trading individual stocks). The line between passive investing and active investing will fade, and we'll see more research into the benefits of a hybrid approach (which is unfortunately lacking at the moment).

Anyway, this comment is long enough as is (I really enjoy talking about this stuff). Happy to read your reply if you write one. For the interest of avoiding a nest of comments, though, I won't respond, and am happy to give you the final word.


Finance is for everyone.

Finance is for everyone.