While passive investing is good for investors, the question is, whether it is also good for the market as a whole? In the US, the passive funds are seen to be detrimental to the market as a whole. A substantial rise in the inflows to ETFs & Index funds alters the market efficiency as passive funds don’t buy less when stock prices are high or invest more when prices are low. Here any stock that has done very well in price parlance is added to the index, and an underperforming stock is weeded out. Hence, all the passive strategies tracking that index will have to rebalance their funds by buying the stock that is already high, increasing the stock price, thereby reducing market efficiency.
ETFs in the US have reached a scale where these investments are impacting the foreign emerging economies. One of the reasons for this could be expense ratio difference between active and passive. In 2008, mutual funds in the US had enormous amount of entry fees, paired with a high minimum fixed price for entry. Front-load fees for mutual funds could be as high as 4.5% at the time. Such was the inflated cost one paid for an expert investor.
In India, the play is different, here ETFs are enabling Indian savings in the right direction. Its market here is not deep enough to create a negative economic impact. On the cost front as well, most ETFs do not offer significant savings when compared to the top-performing active counterparts. Hence investors are convinced to consider both mutual funds and ETFs while creating their portfolio.
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Views expressed above are the author’s own.