What happens if the market becomes 100% passive investments?

Kmagic

Long post to follow.

I just finished the most recent episode of freakonomics radio, it covered investing i.e. active vs passive funds. And left me wondering.

My very basic understanding of the stock market is as follows:

Lets say we have 20 companies, 10 build robots, 10 make medication. Each companies shares are worth €1 each right now, each with one share holder. Total value in stock market, €20.

Now lets say the robot uprising is coming, and you want in on the ground floor, making the shares double to €2 each, and nobody wants medication anymore, cos robots, so those shares half to €0.50. This now means that the total market value is €25 (10 × €2 & 10 × €0.50) and your index fund increases by 25%?

My question however is, lets say everyone moves their money to passive funds via index or ETF funds. Now that there is nobody actively managing funds and moving money into and out of different companies and shares, what happens to the market? Stagnation? What moves share prices? What drives growth when people are no longer playing the field? And at what point do we need a stock market?

I believe he sad about 30% of the market is in passive investments. I just thought some more learned people may see something I'm not.

Dardania

I too listened to that podcast - was very good. 

My opinion on it is that the competitive forces involved between the companies that make up the markets (like you AAPLs, or your IBMs etc.) will be the ones that drive the market. And after that, it's down to inflation, and your choice of passive instrument (e.g. if I track the S&P, and it has a bad year, will some of that market share for goods or services go to companies on a DAX ETF?)
So you then have to have a nice spread of passive funds....

Nody

Kmagic wrote: »

My question however is, lets say everyone moves their money to passive funds via index or ETF funds. Now that there is nobody actively managing funds and moving money into and out of different companies and shares, what happens to the market? Stagnation? What moves share prices? What drives growth when people are no longer playing the field? And at what point do we need a stock market?

I believe he sad about 30% of the market is in passive investments. I just thought some more learned people may see something I'm not.

There will never be a 100% passive market for starters; add in bot trading on top and the markets will always move along with the billionaire speculators etc.

What I expect to see however is a heavy shift from passive funds and active funds to robot traded funds. That's robots set up to trade accordingly to a specific strategy instead of paying a company for a whole department there's only a robot doing the calculations which will drive down the cost of active funds accordingly (which is then likely to shift people over to said active robots instead who're not pure index based). Same thing with advice on what stocks to buy; I expect there will be a whole lot more robot advice (based on numbers obviously) than today's paid advertisers (there's something silly in the bias towards buy over sell if you look at the human recommendations as a group due to wanting to make sure they get to keep going to the back room meetings).

Kmagic

Kmagic wrote: »

........... lets say everyone moves their money to passive funds via index or ETF funds.....................

I can never see that happening.
There will always be a huge amount of people trying to beat the market by their own bespoke portfolios.

zpehtsfd

Kmagic wrote: »

My question however is, lets say everyone moves their money to passive funds via index or ETF funds. Now that there is nobody actively managing funds and moving money into and out of different companies and shares, what happens to the market? Stagnation? What moves share prices? What drives growth when people are no longer playing the field? And at what point do we need a stock market?

The large institutions will always look to beat market benchmarks in order to attract clients and make more money then the next group. That will never change. Also shorts tend to target specific companies which drives share volatility.