In a recent article for ETF.com, Larry Swedroe breaks down concerns regarding passive investing, including the notion that it has “become such a force that the market’s price discovery function is no longer working properly.”

Swedroe, director of research for the BAM Alliance, makes the following points:

• A recent Vanguard study showed that, as of October 2017, $10 trillion was invested in index funds. “While a large figure,” Swedroe writes, “it represents less than 20% of the global equity market. Is there anyone who thinks the other 80% of assets are handicapped in their price discovery efforts?”
• On the active investing side, Swedroe points out that it wasn’t until 1950 that the number of mutual funds exceeded 100. “Essentially,” he argues, “Wall Street wants you to believe that, while 60 years ago the markets were operating efficiently with only about 100 actively managed funds, the markets are no longer functioning well when we have close to 20,000 active funds.”
• Swedroe asserts that active managers play an important “societal role. Specifically, their actions determine security prices, which in turn determine how capital is allocated.” Passive investors, he asserts, are “free riders” that receive all the benefits from the role active managers play.
• Notwithstanding, Swedroe questions whether the costs associated with active management are substantiated by performance. He cites findings outlined in his book “The Incredible Shrinking Alpha” that show how the percentage of active managers able to generate “statistically significant alpha” has fallen from 20% twenty years ago to 2% today.

Swedroe concludes: “While no one knows exactly how many active institutional managers are needed to keep markets functioning well, it’s almost certainly a fraction of the size of today’s industry.” Reiterating the point that markets worked well when the mutual and hedge fund industries were smaller , he writes, “Thus, there is no reason to believe it would not do so again if the active industry shrunk. I believe investors certainly would be far better off.”