Has the growing share of index funds and ETFs changed the market dynamics?
I had this discussion with some of my colleagues the other day. I am of the view that when you have a market participant that is only a buyer when stocks rise, and when that market participant is growing its share of the overall market, that will have an impact on markets dynamics. E.g. the more Amazon rises, the more index funds and ETFs will buy. Active funds, value investors, etc might not be potential buyers of Amazon at these levels, and has probably not been for a long time.
However, a colleague of mine disagreed that ETFs and index funds have not changed the market dynamics, and he claims that it is still active funds who sets the price and are the marginal buyers. He says that it does not matter if money flows into index funds and ETFs, because they will have an equal effect on all stocks, i.e. they will proportionately buy the whole index so all stocks will benefit equally.
However, we know from CFA level 3 that this is not the way index fund are run, i.e. they do not replicate the entire index.
Anybody who has any views on this matter? How has the growing share of index funds and ETFs affected market prices and are active investors still the marginal investors and sets the price?