3 ms·

Think of it this way: if there are too many "free riders" in the form of passive investors, then ... it will become easier for active investors to make money, a

Think of it this way: if there are too many "free riders" in the form of passive investors, then ... it will become easier for active investors to make money, and beat the market, and more people will actively invest their money (or invest in actively managed funds).

orojackson 6y ago
Yep, there will usually be opportunities for arbitrage for active traders if there are too many passive investors. I suspect there will be some sort of equilibrium between active and passive at some point. The thing is that I'd rather be doing other things with my time, so I'm a passive investing kind of guy. Imagine getting the market return for doing nearly nothing for dirt cheap. That's a high growth rate to level of effort ratio!
acover 6y ago
An equilibrium exists but expected returns of active and passive are unknown. Would it reach equilibrium or could there be a crisis due to passive allocating funds poorly.
- saalweachter 6y ago
  I mean, I don't know, I'm a random guy on the internet saying stuff, not an analyst. But I think a key point is that active investing already exists and dominates the market -- it's still like 85% active. People choosing to invest in passively managed funds are doing so because they see a higher return. Maybe the choice is sticky and people won't switch back if the returns begin to fall, but people still have to switch in. So building up a surplus of passive investors requires people to continue to switch to a passive strategy after the returns between passive and active level out and reverse. And not just a little -- profits from investing are returned to investors, and reinvested. So if the equilibrium between active and passive investing is X% of the market passive, and we get up to passive investors at X+10% of the market, then the X+10% of passive investors will see a lower rate of return than the 90-X% of active investors. Which means -- unless those active investors take their surplus profits and dump them into then-less-profitable passive funds, before long the active investors will have 91-X% of the market and the passive investors will have 9+X%. Absent continued switching, the feedback of profit re-investment will push the balance back to equilibrium.
deleted 6y ago
[deleted]

orojackson 6y ago

Yep, there will usually be opportunities for arbitrage for active traders if there are too many passive investors. I suspect there will be some sort of equilibrium between active and passive at some point. The thing is that I'd rather be doing other things with my time, so I'm a passive investing kind of guy. Imagine getting the market return for doing nearly nothing for dirt cheap. That's a high growth rate to level of effort ratio!

acover 6y ago

An equilibrium exists but expected returns of active and passive are unknown. Would it reach equilibrium or could there be a crisis due to passive allocating funds poorly.

saalweachter 6y ago
I mean, I don't know, I'm a random guy on the internet saying stuff, not an analyst. But I think a key point is that active investing already exists and dominates the market -- it's still like 85% active. People choosing to invest in passively managed funds are doing so because they see a higher return. Maybe the choice is sticky and people won't switch back if the returns begin to fall, but people still have to switch in. So building up a surplus of passive investors requires people to continue to switch to a passive strategy after the returns between passive and active level out and reverse. And not just a little -- profits from investing are returned to investors, and reinvested. So if the equilibrium between active and passive investing is X% of the market passive, and we get up to passive investors at X+10% of the market, then the X+10% of passive investors will see a lower rate of return than the 90-X% of active investors. Which means -- unless those active investors take their surplus profits and dump them into then-less-profitable passive funds, before long the active investors will have 91-X% of the market and the passive investors will have 9+X%. Absent continued switching, the feedback of profit re-investment will push the balance back to equilibrium.

deleted 6y ago

[deleted]