The Rise of the Passive Brigade

Abstract

At the heart of modern finance lies hidden a carefully concealed dichotomy. For financial markets to function well, prices must reflect fundamental information. Yet, it is precisely when markets are functioning well that incentives to gather information completely disappear! No recent phenomenon exemplifies this paradox better than the massive growth of passive funds in Western markets in the last decade. While the financial powers that be have remained fixated with quantitative easing and anaemic economic growth, the charm of passive investment has cast its spell on markets quietly, almost unnoticed at first. Yet the growth of the passive brigade represents a fundamental shift in the practice of finance, as big as any we’ve seen in the past, creating new challenges for regulators, market participants and academics alike.