ADDENDUMA Passive Investing Bubble?
If everyone indexed, the only word you could use is chaos, catastrophe. The markets would fail.
—John Bogle
One of the biggest battles in the investing world over the past two decades has been between active and passive approaches to investing. The efficient market hypothesis, which we described in Chapter 1, contends that market prices reflect all available information; therefore, there is no advantage whatsoever to doing research or conducting analysis of any sort. Better instead, the argument goes, to take prices as given and minimize investment fees. In recent years, the boom in passive investing suggests that allocators tend to agree with the efficient market hypothesis.
Is this a problem? Well, as noted in the quote from John Bogle, if everyone were doing it, the markets would fail. Bogle, arguably the father of passive and index investing as founder of Vanguard, is being literal. That is, he says if literally everyone were investing passively, through an index fund, no one would be trading individual securities or helping to determine appropriate prices for securities. The price-discovery mechanism would break down, and prices would no longer reflect a negotiated agreement between buyers and sellers. Capital allocation would grow increasingly inefficient, and securities prices would deviate further and further from fundamentals.
Of course, the odds of everyone actually investing passively are probably very low. But is there a point ...