Editing Index fund (section)

==Economic theory==
Economist [[Eugene Fama]] said, "I take the [[efficient market hypothesis|market efficiency hypothesis]] to be the simple statement that security prices fully reflect all available information." 
A precondition for this "strong version" of the hypothesis is that information and trading costs, the costs of getting prices to reflect information, are always 0.<ref>Grossman and Stiglitz (1980)</ref>{{Full citation needed|date=December 2023}}
A weaker and economically more sensible version of the efficiency hypothesis says that prices reflect information to the point where the marginal benefits of acting on information (the profits to be made) do not exceed [[marginal costs]].<ref>Jensen (1978)</ref>{{Full citation needed|date=December 2023}}

Economists cite the [[efficient-market hypothesis]] (EMH) as the fundamental premise that justifies the creation of the index funds. The hypothesis implies that [[Investment management|fund managers]] and stock analysts are constantly looking for securities that may out-perform the market; and that this competition is so effective that any new information about the fortune of a company will rapidly be incorporated into stock prices. It is postulated therefore that it is very difficult to tell ahead of time which stocks will out-perform the market.<ref name="burton">Burton G. Malkiel, ''A Random Walk Down Wall Street'', W. W. Norton, 1996, {{ISBN|0-393-03888-2}}</ref> By creating an index fund that mirrors the whole market the inefficiencies of stock selection are avoided.

In particular, the EMH says that economic profits cannot be wrung from [[stock picking]]. This is not to say that a stock picker cannot achieve a superior return, just that the excess return will on average not exceed the costs of winning it (including salaries, information costs, and trading costs). The conclusion is that most investors would be better off buying a cheap index fund. Note that return refers to the [[ex-ante]] expectation; [[Ex post#ex post|ex-post]] realisation of payoffs may make some stock-pickers appear successful. In addition, there have been many [[Efficient-market hypothesis#Criticism|criticism]] of the EMH.

Some legal scholars have previously suggested a value maximization and [[agency theory|agency-costs theory]] for understanding index funds stewardship.<ref>{{Cite journal|last=Hirst|first=Scott|date=2019-09-01|title=Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy|url=https://scholarship.law.bu.edu/faculty_scholarship/477|journal=ECGI - Law Working Paper|volume=433/2018}}</ref>'''{{rp|4}}'''