“But investors are growing more risk averse and with its low fees and “buy-the-market” mentality, passive investing has an intuitive appeal over active. So while active’s AUM may be growing, its market share is shrinking. The PWC report projects that by year-end 2020, passive investments will make up 21% of global AUM, up from 17% in 2016. Active will be down to 66% from 71%.

This means that markets are becoming ever more efficient with fewer undervalued/mis-priced securities and thus fewer opportunities for alpha generation.”

A greater passive share will likely create greater mispricings and more opportunities to generate alpha for active managers. Most indices are market cap weighted, which results in passive allocation based on size (Market cap). It fails to consider the price relative to earnings (or other fundamentals) that drive value.

The passive mechanism encourages investors to buy expensive stocks in greater magnitudes as market share grows and the opposite when the market share shrinks.

This could result in buying high and selling Low depending on the underlying fundamentals. So I would not agree that an increasing passive share results in more efficient markets.

I’d also like to comment on management fees and churn/turnover. The turnover wont impact management fees ( the fee the investor pays the manager to invest their funds) as this depends on AUM. But it will impact trading costs.

Higher turnover will increase trading costs and reduce return. This reduction in return compounds over time so it’s very important to keep turnover low.

However, trading costs have fallen significantly and continue to do so this impact on the portfolio is decreasing!