The Impact of Passive Investing on Corporate Valuations

Abstract

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.

Keywords: Active management, passive management, indexing, index fund, index premium, demand curves for stocks, S&P 500

JEL Classification: G11, G12, G23