Passive investing has seen amazing growth over recent decades, as more people turn to lower risk funds that track broad measures of the market and with their low management fees, index funds are an attractive option, writes James Ledbetter for The New Yorker.

This type of investing was not available until the latter part of the twentieth century. Before that, people who wanted to invest their money in the stock market had no option but to buy individual stocks. However, at the start of the 1970s academic models on indexing stocks started to achieve momentum. This gave Jack Bogle, the founder of Vanguard, the idea to introduce the very first index mutual fund in 1975.

Initially, Bogle’s approach was slow to gain popularity, but during the first fourteen years of this century, money invested in Vanguard type index mutual funds more than quintupled. This trend was further accelerated by the rise in exchange-traded funds, which while indexed to a broad market or sector, still trade daily as stocks.

Today, as much as 20 percent of stocks are owned by index funds. However, this has created new worries for some scholars and economists, primarily whether this phenomenon is having a negative effect on the economy as a whole.

The main concern is that the entry of passive investors into markets that form prices based on demand distorts the demand signals, as they are buying without using traditional indicators. Due to this, it can be more difficult for manufacturers to predict demand, potentially increasing costs.

A good example of this was raised in a discussion paper last year. It determined that index funds were affecting prices in the airline industry, where close to 80 percent of all shares are owned by a relatively low number of investors. The paper argues that institutional investors, primarily index funds such as Vanguard and Fidelity, are therefore playing an oversized role in the sector. The rapid adoption of these funds leads to accelerated ownership concentration, which in turn causes higher prices for travellers.

Read the complete feature on The New Yorker here, and check out previous VISTA Today coverage of Vanguard here.