The argument from Mike Green is the opposite of what I have heard before - "Increased passive investment = more difficult to be an individual stock picker."
If you take a look from 40 minutes into the interview (https://www.youtube.com/watch?v=ON6U6IMn8GI), he starts debating this problem, which I understand as follows:
Despite its apparent simplicity, passive investing can have unintended consequences, especially when a large portion of the market is passively managed. Here's how:
- Less Price Discovery: Price discovery is the process where supply and demand determine a security's fair price. With fewer active investors analyzing companies, passive funds might not react efficiently to new information impacting a company's value. Prices may not reflect true fundamentals.
- Reduced Market Elasticity: Imagine a rubber band. A healthy market is elastic, meaning prices adjust smoothly to new information. If passive funds dominate, the market might become less elastic. Prices may become "stickier" and not adjust as readily, potentially leading to larger price swings later.
- Difficulty for Active Managers: Actively managed funds aim to outperform the market by strategically selecting investments. If the market is mostly passively managed, there may be fewer investment opportunities for active managers to exploit, making it harder for them to beat the market.
Do you agree?
Here is the timestamps:
Timestamps: 0:00:00 Intro 0:06:49 The effect the growth of indexing has on markets 0:08:46 The XIV trade that strengthened your belief in this view 0:15:29 Beyond the XIV trade, the evidence we have that indicates this is a problem 0:19:07 How we know that index funds have less elastic demand than the counterfactual security holders in the absence of index funds 0:21:37 Why flows into a cap weighted index fund are different from flows into the aggregate of active, which holds the market 0:31:54 How much of an issue this is in markets outside of the US 0:33:46 How systematic firms like Dimensional and Avantis, that tilt away from cap weights, fit into these dynamics 0:40:55 How the issue created by index fund ownership is distinct from market efficiency 0:46:55 How investors should change their strategy in response to the current market structure 0:53:54 As a portfolio manager, how Mike incorporates his views on passive into investment strategies 0:59:20 Whose responsibility it is to fix these market structure problems 1:05:39 Separate from the index fund effects, what Mike's outlook on US equity expected returns is 1:09:04 Why Bitcoin isn’t the solution to all monetary and fiscal policy problems 1:12:50 Mike Defines Success in His Life