Due Diligence

“I favour passive investing for most investors, because markets are amazingly successful devices for incorporating information into stock prices.” – Merton Miller – Nobel Laureate in Economics

Merton Miller, Nobel Laureate in Economics, was a pivotal figure in the development of modern financial theory and a leading advocate for passive investing. The quote, “I favour passive investing for most investors, because markets are amazingly successful devices for incorporating information into stock prices,” encapsulates Miller’s lifelong commitment to highlighting the power and efficiency of financial markets.

About Merton Miller

Miller (1923–2000) was awarded the Nobel Prize in Economic Sciences in 1990, sharing the honour with Harry Markowitz and William Sharpe for ground-breaking work in the field of financial economics. His most influential contribution, alongside Franco Modigliani, was the Modigliani-Miller theorem—a foundational principle which rigorously proved that, under certain conditions, the value of a firm is unaffected by its capital structure. This theorem underpinned the belief that markets price information efficiently and forms an intellectual basis for the case for passive investing.

Beyond his Nobel-winning research, Miller was renowned for his candid commentary on investing. He consistently argued that, while individual investors might believe they possess superior insights, markets—comprised of thousands of informed participants—collectively synthesise information so effectively that it becomes extremely difficult for any single investor to outperform the index after costs. As he famously quipped, “Everybody has some information. The function of the markets is to aggregate that information, evaluate it and get it incorporated into prices”.

Context of the Quote

The quote is a summation of decades of academic research and market observation. Miller, reflecting on the odds of outperforming the market, reasoned that for “most investors”, passive investing is the only rational route. He noted the steep costs of active management—not just fees, but the resources required to “dig up information no one else has yet”. For Miller, market prices reflected the best available information, making attempts to “pick winners” a game of chance rather than skill for the majority.

This view gained substantial traction, especially as the academic tradition moved toward the concept of market efficiency. Miller warned pension fund managers that failing to allocate the majority of their portfolios to passive strategies—typically 70–80%, by his estimation—was not just suboptimal, but potentially a breach of fiduciary duty.

Leading Theorists in Passive Investing and Market Efficiency

The academic roots of passive investing run deep, with a lineage of Nobel Laureates and theorists who shaped the discipline:

• Eugene Fama: Often called the ‘father of the Efficient Market Hypothesis (EMH)’, Fama empirically demonstrated that markets are largely efficient, quickly reflecting all publicly available information in asset prices. This theory provides the intellectual justification for index investing and the idea that beating the market is exceptionally difficult for most investors.

• Harry Markowitz: Awarded the Nobel in 1990 alongside Miller, Markowitz’s work on Modern Portfolio Theory showed how diversification can minimise unsystematic risk. His ideas underpinned the structure of index funds, designed to capture broad market returns rather than pursue potentially elusive ‘alpha’.

• William Sharpe: Another 1990 Nobel Laureate, Sharpe introduced the Capital Asset Pricing Model (CAPM), which articulated the relationship between risk and expected return. Sharpe was an early proponent of index funds and highlighted the drag of management fees on investor outcomes, recommending that expense ratio should be a key screening criterion for investors.

• John Bogle: Although not an academic, Bogle was the founder of Vanguard and the pioneer of the first index mutual fund. His philosophy—“Don’t look for the needle in the haystack; just buy the haystack”—embodied the joint lessons of market efficiency and diversification.

• Michael Mauboussin and Andrei Shleifer: Recent voices have further nuanced the debate, discussing the effects of passive flows on share prices and revisiting demand curve theory in stock markets. While the consensus remains in favour of passive investing for most, ongoing dialogue underscores both the robustness and the boundaries of market efficiency.

Broader Context

The shift towards passive investing is not merely theoretical but has reshaped global markets. Decades of empirical research confirm Miller’s central insight: most investors “might just as well buy a share of the whole market, which pools all the information, than delude themselves into thinking they know something the market doesn’t”. Despite periodic debate—such as whether passive investing could itself distort markets—the evidence and leading academic voices overwhelmingly endorse its primacy for the majority of investors.

Key Themes

• Market Efficiency: Prices reflect available information; isolated investor insight is rarely enough to reliably outperform.

• Diversification: Passive instruments such as index funds enable broad market exposure and risk minimisation—a tenet shared by Markowitz and Miller.

• Cost Effectiveness: High fees persistently erode returns; passive strategies offer a more efficient alternative for most.

• Fiduciary Duty: Miller asserted that those responsible for large pools of savings, such as pension funds, are ethically and practically compelled to choose passive allocations.

Summary Table: Leading Theorists in Passive Investing

Merton Miller’s quote stands not as a passing remark, but as the distilled wisdom of a career devoted to understanding and proving the power of markets. It is a touchstone statement for a generation of investors and fiduciaries committed to evidence over speculation, and efficiency over expense.