Individually, it's rational to go with a low cost index fund rather than a high cost manager or picking stocks yourself.

But I also think there's something fundamentally broken and self-referential when the majority of fund flows are determined by passive rules rather than research into a company's financial prospects.

Traditionally the thinking was that the price was determined by a thick market of traders doing their own research. The market price then reflects the marginal trader's opinion as to the value of the stock.

But what happens when the marginal trade price is determined by passive fund flows rather than financial analysis? Price may no longer reflect a trader's opinion of the financial value of the company but instead reflect some aggregation of the rules that govern the major passive funds.

Traders, then, in response to this, now need to base their stock valuations on an analysis of these passive rules rather than on financial analysis of the company. Thus increasing the self-referentiality of the markets.

I think this is what is scaring people. I'm not sure what to think, honestly. But I can see why some people think the dominance of passive funds means that "price discovery" is broken.