When people wonder what would happen if index funds become too popular, I usually refer them to Warren Buffet's 2005 essay, 'How to minimize investment returns':

http://www.mymoneyblog.com/how-to-minimize-investment-return...

It is essentially a thought experiment about what would happen if everyone switched to one big index fund.

But, it glosses over the issue of individual security pricing and corporate management, which would become issues in a 100% pure index environment.

Of course, we won't ever get a 100% pure index environment, because the closer you approach it, the more incentive there is for active managers to exist.

I think what is really happening is that as more people use indexing, the less talented active managers are driven out of business. A small number of very talented active managers may eventually find themselves in a highly competitive market to exploit pricing inefficiencies, and they will end up incidentally providing management oversight and marginal pricing services to the indexers. These active managers will probably look more and more like private equity firms (taking an active hand in management), and less and less like traditional arms-length traders.

As long as this small number of talented firms isn't allowed to collude with each other, or self-deal unethically by controlling management, everything should be fine. In fact, having met some less talented active traders in person, I suspect that the quality of marginal pricing and managerial oversight may go _up_ as the number of active managers decreases, and the less informed and talented among them are eliminated.