Worth noting that articles about how passive investing destroys the market date back to, maybe, 2016 or earlier...

https://www.newyorker.com/business/currency/is-passive-inves...

March 9, 2016

> O’Neill fears that the result will be a “bubble machine”—a winner-take-all system that inflates already large companies, blind to whether they’re actually selling more widgets or generating bigger profits.

Part of the problem is that if you look at the stellar long-term performance of indexes, they are largely explained by a small number of stocks in the index that perform extremely well… but you don’t know ahead of time which stocks those are. If you want the performance of the S&P500, you need a similarly diversified portfolio, the theory goes. It is hard to get a portfolio with that kind of diversity unless you buy index funds.

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greyw 3 hours ago | parent | next [-]

IIRC a huge chunk of the returns comes from roughly 4% of all stocks while the rest is basically (very simplified) just earning their cost of capital.

	▲	jackcosgrove 3 hours ago \| parent \| next [-]
		And anyone who thinks they can consistently predict who will be among the 4% is... mistaken. Diversification is how one manages risk when a system has a power law distribution of outcomes. Trying to beat the market is playing a zero sum game. Someone has to lose for you to win. I understand savvy winners add information, but most winners are just lucky and it still makes me uneasy to play a zero sum game. When you simply try to match the market, you float on the tide that mostly raises all boats and sometimes lowers them. That sits much better with me.
	▲	cortesoft 3 hours ago \| parent \| prev [-]
		Yes, my understanding is that the cost of missing out on those companies that are providing the returns is much more costly than investing in a company that is NOT generating those returns. In other words, the risk is to miss the winners, not that you will invest in a loser. The problem is that it is very hard to predict the winners, so it is best to invest in all companies to make sure you have the winners

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chongli 3 hours ago | parent | prev [-]

That diversification is a bit of a smoke-screen though. The most popular index funds are cap-weighted. This causes the allocation of capital within the fund to become increasingly dominated by those few winner-take-all companies.

When index funds grow to huge levels of assets under management, their own asset allocations come to make up a significant portion of the market cap of the stocks in the portfolio. Thus the cap-weighted investment strategy becomes a self-fulfilling prophecy.

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klodolph 3 hours ago | parent | next [-]

> Thus the cap-weighted investment strategy becomes a self-fulfilling prophecy.

Either you’re doing the math wrong or you’ve skipped some steps.

Let’s say you have companies X and Y, each with 50% of the market. X is a winner, and the stock price goes from $10 to $45. Y is a loser, and the stock price drops from $10 to $5. The new weight is X=90% and Y=10%.

But this cannot be a self-fulfilling prophecy for index funds, because the index funds do not have to buy or sell any shares of X or Y to keep up (I mean rebalance, specifically). In this scenario, the index funds are just holding. (By “holding” I mean “not rebalancing”.)

This is… an oversimplified scenario. But it illustrates the problem here with the “index funds cause a small number of stocks to be winners” theory. There are alternative theories that make sense, but not this one.

(What makes the scenario more complicated is when you think of buybacks, dividends, delisting, etc.)

	▲	ethbr1 4 minutes ago \| parent [-]
		If new money is then invested into the index fund, it's effectively routed 90% to X and 10% to Y though, no?

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jackcosgrove 3 hours ago | parent | prev [-]

Don't index funds trail market changes though? I thought their allocations are reactive. In other words, the Mag 7 are being bid up by people trying to beat the market. I don't see how index funds could move prices.

I do understand how they can stabilize allocations where they are, which I think is the concern. Zombification rather than a positive feedback loop.