The market distortion from an IPO's index inclusion isn't a one-time event. As insiders' shares unlock months later, the public float increases. Nasdaq's rules will then force index funds to buy even more shares to match the new, higher float (multiplied by 3x), creating a recurring cycle of predictable, forced buying and price distortion.

Counter to the narrative that indexing is killing active management, Davis argues the opposite. As more capital flows into passive funds that must buy and sell indiscriminately, it creates greater market inefficiencies. This environment allows the remaining skilled active managers to more easily exploit mispricings and generate significant alpha.

Contrary to popular belief, the market may be getting less efficient. The dominance of indexing, quant funds, and multi-manager pods—all with short time horizons—creates dislocations. This leaves opportunities for long-term investors to buy valuable assets that are neglected because their path to value creation is uncertain.

Best practice for index funds is to add IPOs within 3-5 days to capture early returns. The critical and often-missed step is to be 'float-adjusted,' meaning the fund only buys a proportion of shares available to the public, preventing index demand from artificially inflating the price of a limited supply.

Market-cap-weighted indexes create a perverse momentum loop. As a stock's price rises, its weight in the index increases, forcing new passive capital to buy more of it at inflated prices. This mechanism is the structural opposite of a value-oriented 'buy low, sell high' discipline.

Many stocks added to the S&P 500 are later removed. Index investors are forced to buy these "flip-flop" stocks *after* they have already appreciated significantly (avg. +75%), only to then participate fully in their subsequent decline (avg. -70%), locking in a substantial loss.

By design, market capitalization-weighted indices increase allocations to assets as their prices rise. This forces investors to continuously buy more of what has already performed well, leading to concentration in popular, often expensive, assets and sectors from the previous market cycle.

Jack Bogle's indexing assumed efficient markets where passive funds accept prices. Now, with passive strategies dominating capital flows, they collectively set prices. This ironically creates the market inefficiencies and price distortions that the original theory assumed didn't exist on such a large scale.

So-called passive indexes have a small but impactful "active side" in their turnover. This component behaves like a flawed momentum strategy, forcing the index to systematically buy stocks after they've surged and sell them after they've plummeted, creating a performance drag.