Abstract:
Index funds have grown significantly in recent years in most of the
developed markets as investors have become less satisfied with the performance of
active managers. Further, the flow of funds to passive investing has been supplemented
by a high level of quasi-indexing undertaken by numerous active managers fuelled by
their perception that they have to strictly control their tracking error relative to their
given benchmark. The focus of this paper is on the economic implications of this major
swing to passive investing. In particular, the paper highlights that (1) the assumed
constraints on the growth in passive investing envisaged by writers such as Lorie and
Hamilton (1973) is never likely to come into play; and (2) a high level of passive
investing is likely to contribute to excessive and wasteful investment which results in
lower economic growth and investor retums. This all suggests that although a heavy
reliance on passive investing might appear rational for investors, it may well prove not
only to be to their economic detriment but also that of the national economy.
