This feature examines how the long-term expansion of index investing could change the way stock prices are determined and the structure of the market. As indexes and capital flows take center stage over analysis of individual stocks, the question of who sets prices becomes the focus.
This article examines the growing shift in capital from traditional analysis of individual companies, which has historically played a role in determining stock prices, toward passive investments linked to indexes. Investors are increasingly inclined to look at the market as a whole and choose how to allocate their assets, rather than closely evaluating the future prospects of individual stocks.
The rationale for passive investing includes pursuing the market average over the long term while keeping stock-selection costs and fees low. At the same time, as fewer investors assess the future prospects of the companies that make up the market as a whole, stock prices may come to be determined by index rules and capital flows.
A contradiction in the formation of stock prices is the concern that the market’s ability to aggregate information and incorporate it into prices may weaken, alongside the possibility that more market participants could emerge to correct mispricing if it occurs. The impact of growing passive investment could extend beyond whether prices are simply right or wrong, affecting capital allocation and corporate governance as well.
This article does not seek to determine whether passive investing is good or bad. Instead, it breaks down and examines who moves prices, when and how. It explains that the roles of various participants, including index providers, market makers, active investors and corporate executives, shift depending on the circumstances.