Ceresna Comment: Important article written by Michael Lebowitz highlighting the flaws in passive investing using indexing. I would summarize that as indexing becomes more popular, the more it will distort the market pricing and increase the risk to those believing it to be a conservative strategy. The more the public pours into the strategy, the more likely it is to be the epicenter to the next major market event. The smaller and smaller the active management sector gets, the more likely that there will be considerable opportunities presented to the few dinosaur managers left using bazaar voodoo techniques like bottom up value investing.
JP Morgan's Nikolaos Panagirtzoglou:
Markets become more brittle, risky: "The shift towards passive funds has the potential to concentrate investments to a few large products. This concentration potentially increases systemic risk making markets more susceptible to the flows of a few large passive products."
Crashes, when they happen, will be bigger and badder: "the shift towards passive funds tends to intensify following periods of strong market performance as active managers underperform in such periods of strong market performance. In turn, this shift exacerbates the market uptrend creating more protracted periods of low volatility and momentum. When markets eventually reverse, the correction becomes deeper and volatility rises as money flows away from passive funds back towards active managers who tend to outperform in periods of weak market performance."
Markets become less efficient: "if passive investing becomes too big, potentially crowding out skilled active managers also, market efficiency would start declining. In turn, this would present opportunities for active managers to extract arbitrage profits."