Does passive investing make the markets less efficient? Copy
The argument is that passive investing makes a market less efficient because as fewer people follow active investing, there are fewer resources dedicated to accurately pricing assets in that market, so more assets can move away from their fair market value without being discovered and exploited. This then creates more opportunity for active managers, so they should be able to do better.
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The first rebuttal is that in the information age, much more and complete information is readily available to everyone in the market.
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. Secondly, it is likely that in a shrinking active manager market, that the smaller and less successful asset managers will leave first. This means that the best skills and resources remain, and these should be better at correctly pricing assets and maintaining market efficiency.
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Thirdly, while passive funds hold for example some half of the share assets invested in U.S.-listed mutual funds and ETFs, they tend to trade far less than active managers, making up less than 5% of trading volume on the US exchanges. The efficient market pricing of a share happens when it is sold/ bought, but 95% of trading happens in the actively managed space, not the passive space. This means that active managers continue to dominate market pricing and thereby maintain market efficiency.