Excess Returns Podcast: "The Line We Can't Cross | Mike Green on the Passive Investing Endgame"
Date: January 20, 2026
Host: Excess Returns (Jack Forehand, Justin Carbonneau, Matt Zeigler)
Guest: Mike Green (Chief Investment Strategist and Portfolio Manager, Simplify Asset Management)

Episode Overview

In this episode, the Excess Returns team sits down with Mike Green, a leading voice on the impact of passive investing, to discuss the structural changes passive strategies are bringing to markets. The conversation explores the findings from new academic research, limitations of current dominant narratives, the risks arising from the growth of passive investment vehicles, and why we may be heading toward a critical threshold where markets cease to function as we know them.

Key Topics & Discussion Points

1. Setting the Stage: What Are Inelastic Markets?

• The Inelastic Market Hypothesis:
  • The idea, formalized by academics Xavier Gabay and Ralph Koijen (2020), holds that as passive investing grows, markets become less able to absorb demand and supply shocks without significant price impact.
• Mike Green’s Contribution:
  • Green argues passive vehicles are never truly "passive" because fund flows create continuous trading. This violates Bill Sharpe’s original definition, which assumed true passivity means never transacting (03:02–08:18).
  • Quote:
    "Every single day these index funds and ETFs receive inflows or outflows ... they are continually trading, they are continually executing in markets and as a result, they don't at all fit the definition that Bill Sharpe provided in the Arithmetic of Active Management." (00:00–00:32, 03:02–05:30)

2. How Much Passive Is Too Much? (Tipping Points & Endgame)

• Danger Zone Estimates:
  • Academic and Green’s own model suggests that if roughly 75–83% of market assets are passive, markets become so volatile they can't function; closure or intervention becomes inevitable. This estimate assumes no inflows or outflows—adding those in lowers the dangerous threshold (08:18–12:06).
  • Current Level:
    • Mike Green puts the current passive share at ~54%, up 4% in the past year. At this rate, “we would be looking at somewhere in the neighborhood of five years out, the world comes to an end.” (00:40, 09:13–09:47)
• Market Mechanisms and Potential Interventions:
  • If we approach tipping points, Green anticipates "extraordinary responses," including government intervention (12:06–13:30).

3. Flows, Demographics, and the Feedback Loop

• The Retirement Effect:
  • As boomers retire, outflows from passive vehicles accelerate, drawing down flows that propped up prices—potentially moving us closer to crisis sooner (14:27–15:30).
• Younger Investors:
  • Almost all new 401(k) contributions (95%) go into passive target-date funds—further reinforcing the trend (18:37–19:15).
• Mutual Fund and ETF Nuances:
  • Redemptions are now observable from large passive mutual funds (Vanguard), offset so far by ETF inflows, but the net is “getting closer to zero.” (14:44–15:30)

4. Counterpoints from Vanguard – Green’s Rebuttals

An extended segment addresses Vanguard’s pushback on the dangers of passive investing, point by point:

A. Trading Volume Misconceptions

• Vanguard’s View: Passive vehicles are a small portion of trading volume.
• Green’s Reply:
  • This is "stupid": The impact is far greater when accounting for the indirect trading, market making, ETF rebalancing, and hedging. Passive-related activity now makes up ~80% of trading volume, up from 20% in 1995 (19:42–21:38).
  • Quote:
    "Passive trading now makes up roughly 80% of market volume on a daily basis ... I candidly think that Vanguard should be held liable for misleading people at this point." (19:42–21:38)
• Implication:
  • As active management shrinks, what is left becomes progressively more index-like, reducing elasticity and further reinforcing the passive feedback loop.

B. Ownership % in Mid Cap vs. Large Cap

• Vanguard’s View: Passive funds own more of the mid-cap universe than of large-caps; why aren't distortions showing up in mid-caps?
• Green’s Reply:
  • Vanguard is intentionally misleading by lumping in non-market-cap-weighted funds (like REITs). Most "mid-cap" passive exposure is due to portfolio construction rules and does impact prices, but such strategies are not the true driver in 401(k)s (25:15–26:59).

C. Impact of Flows on Market Structure

• Vanguard’s View: Large firms can absorb flows, so passive flows don't distort relative prices.
• Green’s Reply:
  • Price impact depends on the size of the flow relative to liquidity, not market cap. Apple can see higher price impact due to flow concentration and trading liquidity. Empirical data shows outsized price gains for large-cap tech even without superior fundamentals (27:16–31:25).
  • Quote:
    "What we should be seeing in Apple is lower multiples... Instead, it's trading near the highest valuations in its history. I would ascribe that to the impact of passive investing." (30:00–31:25)

5. Active Management in Decline

• Active Managers Becoming "Closet Indexers":
  • To avoid losing clients or lagging benchmarks, active managers are hugging indexes more closely, driving down their elasticity and nullifying any edge (21:38–24:28).
  • Theoretical Contradiction:
    • Paradoxically, market environments crowded with passive investors “should” help active managers (Grossman-Stiglitz), but empirical reality is the opposite, due to systematic flows (24:28–24:43).

6. Regulation, Systemic Risk, and "No Way Out"

• Fee Cuts:
  • Recent high-profile Vanguard fee cuts are described as "raising barriers to entry," not improving investor welfare (34:06–35:49).
• Rational Individual Choices, Irrational Systemic Risk:
  • "For every individual, it is very, very rational to continue to invest in passive funds. But you create a societal problem as more and more people do it." (35:49–36:17)
• Green’s Fatalism:
  • Regulators unlikely to act. Green sees his role shifting to damage mitigation—building portfolio products as armor against systemic failure (36:17–37:59).

7. Macro Market Environment & Real-Time Flows

• Recent Small Cap Rally:
  • Rotation into small caps likely driven by rebalancing flows and "January Effect"-style bets—not fundamentals (39:25–41:45).
• Market Structure:
  • As flows into smaller segments hit increasingly inelastic (less liquid) names, outsized, temporary effects can arise.

8. Economic Outlook, AI, and CapEx

• GDP Data Interpretation:
  • Quarterly GDP numbers can overstate the true trend—real underlying growth is lower (42:11–43:47).
• AI as a Macro Force:
  • Surging CapEx into AI may lead to classic malinvestment, driven by management incentives and inflated equity values.
  • Quote:
    "If you enter into a period of perennial overvaluation, management teams have an incentive to basically adopt that view that their stock is worth what it is trading at and to behave accordingly." (44:14–45:30)
• Impact of AI on Productivity and Power Costs:
  • LLMs make knowledge workers more productive, but most of the population pays higher power bills with little direct benefit; coming strains on electricity grid from data center growth (46:09–52:07).
  • Quote:
    "I would argue that the introduction of LLM subtracted 10 years from my chronological age in terms of the decay of my gray matter..." (49:15–49:30)

9. Housing Market Observations

• Housing shortages are, per Green, largely a mismatch of type and location, driven by demographic choices to “age in place.” Reacting with more building will likely create new distortions (53:27–56:12).

Notable Quotes & Moments (with Timestamps):

• On Passive Vehicles Trading All the Time:
  "Every single day these index funds and ETFs receive inflows or outflows occasionally. That actually means that they are continually trading." — Mike Green [00:00]
• On the Mathematical Certainty of Crisis:
  "Once it becomes a mathematical certainty, if you actually have built a closed form solution that says this is just what the math says will happen, then we're effectively debating math. And to my knowledge, math doesn't fail." — Mike Green [12:23]
• On Passive’s Volume Impact:
  "Passive trading now makes up roughly 80% of market volume on a daily basis... Vanguard should be held liable for misleading people at this point." — Mike Green [19:42–21:38]
• On the ‘Inevitable’ Outflows:
  "We're actually starting to see indications that we are actually beginning to see outflows and that, that, that should be concerning. That pulls those numbers closer, that pulls those dates closer." — Mike Green [15:24]
• On Pricing Distortions at Stock Level:
  "What we should be seeing in Apple is lower multiples... Instead, it's trading near the highest valuations in its history. And I would ascribe that to the impact of passive investing." — Mike Green [31:05]
• On Regulatory Inaction and Fatalism:
  "Candidly, there's a degree of fatalism for me at this point... I was described in an institutional investor as the Cassandra of passive investing." — Mike Green [36:17]
• On AI’s Disruptive Power:
  "I would argue that the introduction of LLM subtracted 10 years from my chronological age ... the world has to be prepared for a 45 year old Mike Green again." — Mike Green [49:15]

Conclusion: Takeaways for Investors

• Passive’s growth is driving volatility, reducing elasticity, distorting prices, and creating systemic risk.
• Widely cited academic models for passive investing are outdated, misunderstanding real-world continuous trading and flows.
• Current demographic and regulatory trends will only accelerate this dynamic unless disrupted.
• Individual rationality (go passive, cut fees) produces system-level fragility.
• Regulatory response or market structure overhaul is unlikely in time—portfolio construction should reflect this risk.

This deep-dive conversation offers a critical and original take on how passive investing is fundamentally reshaping markets—often in ways most investors and even many professionals do not realize, with explosive implications if current trends continue.