[hendzen]

my personal theory is that active management can still produce market-beating returns but the good active managers will rapidly grow their capital base to huge levels where they don't need much outside investment.

On the other hand - now we have a situation where most investment savings by individual investors are tracking passive indexes. But if everyone is indexing - what determines the relative weight of each stock in the index?

The answer is active investors. But with an increasingly smaller field of increasingly skilled investors (with more discretionary capital), we end up with the valuations of companies (and thus how societal time is allocated) competitively determined by a fierce prediction competition between the top active managers (Renaissance, DE Shaw, Citadel, etc).

[qznc]

I guess the big question how much active management is good. According to the article for funds it is now roughly 50%. I believe even 10% is plenty for market efficiency.

[JudgePenitent]

How do you arrive at 10%?

[elromulous]

I was under the impression the relative weights are (often) simply proportional to their market cap. Afaict that's how that works for the sp500 at least.

[hendzen]

Exactly, the relative weights are often proportional to the market cap. So if I invest $1M in the S&P that doesn't actually change the relative weights of the stocks in the index (mostly), since the impact on all of the underlying stock market caps should be roughly even as more money flows in to the stocks with higher market cap and smaller sums flow in to the stocks with lower market cap.

So in the case that say Meta's metaverse initiatives suddenly start taking off with the general population, it will take active investors to invest more in FB to increase FB's marketcap relative to the other stocks in the index so that passive investors are "correctly" allocating to stocks in proportion to their earnings potential.

Obviously there are some caveats here. Passive investors still have to choose an index to invest in, and inflows in to one narrow index (i.e. QQQ) will affect the weights of particular stocks in broader indexes. But the point stands that the relative marketcap ranking between stocks in the index is not affected much by in/outflows in to a particular index, and in some sense indexes are outsourcing their stock picking to active investors that actually try to accurately value individual stocks on an absolute and relative basis.