The impact of passive investing on corporate valuations

What is it about?

Over the past 20 years, a trend toward index fund investing has emerged. Currently, more mutual fund assets are indexed to the S&P 500 than any other index. Prior research on downward-sloping demand curves suggests that widespread acceptance of S&P 500 index investing may push prices of companies in the S&P 500 beyond fundamental values. This paper explores the impact of flows into S&P 500 index funds on corporate valuations. The results show that money flow into S&P 500 index funds is inflating the values of companies in the index relative to those outside of the index.

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Why is it important?

Mispricings among individual stocks arising from index fund investing may reduce the allocative efficiency of the stock market and distort investors’ performance evaluations of actively managed funds.