The Efficient Market Hypothesis is that securities prices represent the best available information in the market, because if they didn't, smart investors would take advantage of the unincorporated information to make money by buying the underpriced securities and/or selling the overpriced ones.
Index fund investors do not do that; they just buy the securities that are listed in the index, which are selected typically because they have large market capitalization or are old, not because they are underpriced. So, to whatever extent the market conforms to the Efficient Market Hypothesis, it's not doing so because of the index fund investors.
> So, to whatever extent the market conforms to the Efficient Market Hypothesis, it's not doing so because of the index fund investors.
I don't disagree. I also don't believe this observation in isolation supports the assertion "too many index fund investors really inhibit price discovery." Remember, that statement was made in the context of today, not in a hypothetical world where only a few lone traders at home trade individual shares and high frequency traders, hedge funds, and pension plans are for some reason no longer willing to place their own bets.
I'd rather not let some of the anti-index investing tropes gain traction, since they're insanely stupid and, to the extent that index investing is good for people who aren't very skilled at investing, quite damaging.
I'm skeptical of the thesis myself, and even if it is correct, I don't think it makes a good argument for sacrificing your own wealth in the service of improving price discovery.
One slight quibble, though: high frequency traders make their money by providing liquidity, not (as far as possible) betting on the future profits of companies.
Oh, that's an interesting point about high frequency trading.
I think the question of what percentage of the market could be invested in index funds before things got weird is an interesting one. It really is hypothetical, though. Independent investors have more sway, not less, as an increasing number of people put money in index funds. There will always be a lot of people who are very rationally (and also depending on the investor... less rationally) unwilling to give that up.
The price of a stock like Tesla is supported due to its inclusion in the S&P 500 index funds. If you asked every person who owns SPY if they'd want to own TSLA, I imagine it would not add up to 100%. If State Street decided tomorrow that they were removing TSLA from SPY, it would crater the stock.
What?