As long as there are at least some active investors left they can, because they follow price changes set by active investors passively.
If index funds start to create systematic valuation errors, active strategies start to perform better and they start to outperform index funds. This is not the case, because index funds beat active fund management constantly over longer periods. (The article raises concerns of corporate governance and accumulation of power that is different issue).
>there is an alternative view that the rise of passive investing will improve capital allocation, because bad active investors will be driven out but good ones will remain. The passive investors can't influence relative prices, since they just buy the market portfolio, meaning that the fewer but better active investors will continue to make the capital allocation decisions. On this view, lower returns to active management are a sign that prices are more efficient and capital allocation is getting better
>index funds beat active fund management constantly over longer periods
This was only the case because 'long periods' include the periods in which free riders (indexes) were small relative to the active and activist shareholders.
When was the last time they did that anyway? Or tried? For a while, Wall Street has been more interested in predictability or volatility than in actual risk. They flat-out don't care whether an investment will tank, so long as they can predict (or sometimes even control) the timing. Or use some minute technological advantage to reap the rewards before someone else does. The very nature of hedge funds is to be good at measuring potential arbitrage rewards, not actual risk. Copycat behavior only exacerbates a problem that already existed.
Sure, as long as there are some individuals or firms who are not invested into index funds. Theoretically they might even prefer this situation, since if they can accurately price equity risk they will make more money if everyone else is wrong.
The real question is, what is the minimum number of active investors required for accurate pricing of risk in a market dominated by index funds? I'm not aware of an answer that is widely accepted as clearly right.
In theory it might only be one! If there's only one active investor, and they find stocks that the index funds have not priced correctly, then the active investor can pounce, make some money, and move the stock toward a more accurate price. The more they do this, the more money they will make, and the more resources they will have for finding and taking advantage of mis-priced stocks.
The real trick is telling what an "accurate" price is, so that you can evaluate whether the market is working properly. Since the purpose of the market is to find the accurate price, asking whether the price it finds is accurate seems like begging the question.
Is the stock market pricing risk accurately now? Was it pricing risk more accurately 40 years ago, before the growth of index funds? There have been plenty of bull and bear markets during that time... and some nasty unexpected shocks.
There are more stocks than an active investor can research the fair value of. If we are talking about a single stock, one active investor with enough money can force the "correct" price.
If index funds start to create systematic valuation errors, active strategies start to perform better and they start to outperform index funds. This is not the case, because index funds beat active fund management constantly over longer periods. (The article raises concerns of corporate governance and accumulation of power that is different issue).
Matt Levine https://www.bloomberg.com/opinion/articles/2016-08-24/are-in...
>there is an alternative view that the rise of passive investing will improve capital allocation, because bad active investors will be driven out but good ones will remain. The passive investors can't influence relative prices, since they just buy the market portfolio, meaning that the fewer but better active investors will continue to make the capital allocation decisions. On this view, lower returns to active management are a sign that prices are more efficient and capital allocation is getting better