@GazD Sure i will give you my views, i have some strong and different opinions on the impact on market structure. Over the last 20 years or so, we have seen a few large changes to the market participants and structure. Firstly, the post-GFc secular growth decline and the collapse in the cost of capital which was and continues to be huge (i won't go into details here). secondly the growth of passive and momentum investing. the size of FUM in both momentum and passive now, given various data i have seen, (difficult to accurately gauge) is that P&M investing is much larger as a class of investing than valuation style investing. valuation i means growth and value, where you attempt to calculate the intrinsic value of the investment. That is a huge change and will impact how markets work, but accurately assessing those changes is quite difficult. I've been thinking about this for about 10 years and am still undecided about how it pans out.

my conclusions so far are that Momentum and passive are interesting in that they do not explicitly consider value when they allocate funds. think about that for a while, most money coming into the market is valuation-insensitive. very unlike the last century. we can see that openly in market action, IMO. what does that mean for active investors?, my take is that you will have longer and larger variations from intrinsic valuations, especially where passive and momentum are most active. to me, that is an opportunity for active investors but with the understanding of the above, that is, as a valuation-driven investor you are going to be in the minority and swimming against a big tide for quite a while. to me, that means there will be great opportunities but rare and you will see large diversions from what can be considered rational valuations for some time. That's the way i am playing it, attempting to give momentum a wide birth and waiting until its exhausted itself. a few days ago i wrote on an investing WhatsApp group (mainly retired and active PM'S) that if you were unkind you could say my whole value add was taking advantage of over-extended momentum, lol.

specifically to passive, if passive rules, i think we see long periods of lower volatility punctuated by large shocks, ala C19, Japanese carry trade etc, but don't overplay it, the marginal buyer/seller sets the ST price and always will, at times that will be passive other times momentum, overleveraged hedge funds, valuation driven investors etc. i am not concerned that much with passive investing, as active investors we can choose our battles, which is a major advantage.

as always could be wrong, i was thinking about writing a long piece on this but have been caught up in stock analysis which never seems to end :)

I believe in the 2030s the industry super funds expect to change to outflows from inflows - a while away but the dynamic may change.

I see passive as mostly momentum. I'd also highlight that passive tends to outperform active most signficantly when indices are becoming more concentrated. They face a harder time when they're becoming less.

A good podcast on this here:

https://open.spotify.com/episode/2SSOS824urvyPwKggj9Vnl?si=y0jQ6XeDQvSNuJ1XakQ7tQ

Mike Green suggests, based on his analysis, that the "constant bid" of passive/index investing is already distorting the price discovery of markets (particularly given the success of 401Ks/IRAs in the US).

However, he admits that the best play for most people is still to go with low cost index funds. But, if I understand correctly, this is setting up for a major fall in markets if/when this trend shifts.

In which case, I'd assume, those who can maintain the course will be the winners as the market swings from being over-valued to under-valued (i.e. a mass swing from people buying index funds to selling will cause the market to swing too far the other way and those still buying will get in a good price and benefit long term).

He states the regulators are aware, agree with his assessment, but are not interested in stepping in.

FWIW, I don't know enough to agree with him, but his argument is compelling. What I do think is, similar to the property market, if true the current trend could continue for a lot longer before it unwinds (which is why I think he admits, for the individual, index investing still makes sense at the moment).

Thanks @Solvetheriddle Food for thought. Really interesting point @Mujo Hadn't considered the possibility that net flows actually reverse in time. @lyndonator will have to take a listen to that pod. Who would think that index funds would turn volatile (or at least more volatile than direct shares)

Also an interesting article on some of the effects of passive indices here too - The butterfly effect, index funds, and the rise of mega caps (substack.com)

"They show that while the impact on the relative market cap of the largest stocks in the US is a tiny 0.3% per quarter, this accumulates over time. After 25 years these tiny shifts in market cap between larger and smaller stocks amount to large-cap stocks being 30.25% larger than they would have been without the rise of index investments!"

But why would the market cap of large stocks in an index react more than the market cap of smaller stocks? 

They find that the larger a company, the more inelastic demand becomes. But when demand is inelastic it means that a small increase in demand leads to a larger increase in price (and hence market cap).

If you are an active fund manager, nobody will blame you for underperformance just because you didn’t own Etsy shares. But try not owning NVidia or Apple shares and then underperform the market and see how your investors will react… Hence, even active investors are forced to hold at least some NVidia and Apple shares no matter how expensive they are. And that tiny difference in demand creates a huge benefit for the largest stocks over 25 years.

Good find @Mujo. Amazing how much they suggest the difference adds up over time.