Victory for Passive! 22 thoughts and questions
Passive has conquered the world. What could possibly go wrong? Quite a lot
1. Many hardcore passive advocates believe victory over active investing is all but complete. It’s hard to argue: Passive now makes up more than half the market and shows no sign of stopping, while its performance has been better too — index trackers have trashed active managers the world over.
The trouble is, complete victory for passive would be good for no one, including passive investors. Passive investing is designed to work alongside active, so if there’s no more active, passive won’t work either.
2. In economics there’s a concept called ‘The Paradox of Thrift’. This says that, while it makes sense for you to tighten your belt if you’re worried about the economy, if everyone does the same it will actually cause the tough times you were worried about.
In investing, we face ‘The Paradox of Passive’: It makes sense for an individual to copy the index, but if everyone goes passive it breaks the system.
3. Passive’s winning traits are feedback loops that strengthen its own selling points: More passive investors mean greater comfort from safety in numbers; lower charges through economies of scale; and better performance as inflows boost index performance over active funds. This suggests passive dominance will keep growing.
So, if it hasn’t already broken the market, it’s prudent to imagine what might happen if it does.
4. An original argument for going passive was to accept that it’s hard to beat the market, and the average investor will fail (because of charges). So why not save time and money by buying the whole market through a low-cost tracker, and accept slightly better performance than the average active fund manager? This was a perfectly sensible thing to do.
But, on the back of index trackers’ stunning outperformance of active managers, this argument has been conveniently forgotten. In the UK, for example, Vanguard’s UK All Share tracker has made 66% over five years, trouncing the average UK equity fund’s return of just 32%. This, say the passivists, is evidence that active managers were even worse than we first thought.
But let’s say the average active fund charges 1% (it’s less than 1%, but it makes the maths easier). If the average active fund returned 32% after those charges, and the index is supposed to be the sum of those active managers, shouldn’t the tracker have made something like 37%? How did it make 66%?
This is great if you’ve held the tracker, but it makes a nonsense of that original ‘settling-for-average’ argument. It also poses the question: If the tracker can perform 29% better than expected, why can’t it perform 29% worse?
5. Passive funds are starting to look like active funds.
For one, they dominate the fund performance tables. In 2018 the top quartile was filled with active ‘quality-growth’ funds, in 2022 it was filled with active ‘high-growth’ funds, and in 2026 it’s filled with index funds: Out of 194 UK equity funds, 12 of the top 20 performers over five years are trackers.
For another, they’re making punchier bets than many active managers. Half of Vanguard’s FTSE 100 tracker is held in just 10 stocks, and it has significant ‘sector bets’ on banks, oil producers and mining companies. Index funds aren’t the low-risk, diversified portfolios they used to be.
6. I recognise the euphoria ardent passivists are enjoying today. You get it when you’ve been proved so decisively right that any other way of doing things seems stupid. Whenever I’ve felt it, it has typically been followed by a painful crash landing as the thing I thought was bulletproof turns out to be anything but.
7. I also recognise the feedback loop that occurs sometimes when a dominant fund is winning: If it performs well, it takes in more capital. If it invests that capital into its own stocks, it pushes their prices up. If its stock prices rise, it performs even better. And if it performs even better, it attracts more capital. And the feedback loop grows.
But at some point the tide turns, the feedback loop reverses, and the high gains turn to large losses.
The biggest instance of this I’ve seen (from the sidelines) was the Woodford Equity Income Fund. This was amazing for its holders when money was flowing in, then terrible when it was flowing out. And then they had to close the fund, trapping investors within.
It feels to me like this feedback loop is now happening at a market level, which is boosting the performance, and therefore popularity, of index funds. This should be cause for concern.
8. A market-wide feedback loop would be different to one that’s limited to a single fund. Could it still reverse?
Quite possibly. In active world, it was always those funds that benefited from the ‘hot’ money flowing in that got hit hard when it flowed out again. So, if something caused hot money to start flowing outwards, like a recession, it wouldn’t be weird to see index funds suffer from that.
This has already happened once, albeit from lower levels of passive dominance: This followed the first big wave of passive popularity in the 1990s, which resulted in amazing returns for a global tracker over that decade, but was followed by negative returns for the next ten years.
If this were to happen, logically the performance of active funds should be considerably better than outflowing index funds (as it was in the 2000s). Perversely, while painful in the short term, such a reset might actually be a good thing for passive investors if it delays a market breakdown caused by excessive market share.
9. One way it could be different this time is that, given its enormity and political importance, index investing may now be ‘too big to fail’. In which case, a deep and prolonged reversal won’t be allowed to happen.
It’s not inconceivable that, should the S&P 500 index drop significantly, the Federal Reserve (under political pressure) will use QE to prop up the market by buying index ETFs.
This might work domestically, but it would weaken the dollar, which wouldn’t help international holders of a US-heavy global tracker.
Either way, it would be mass nationalisation of public companies, and another nail in the coffin for capitalism.
10. Many passive fans are proud capitalists who see buying an index fund as ‘buying a slice of capitalism’. In many ways this is true, but it it’s also ironic: A key driver behind the rise of passive funds has been pressure applied by centrally-controlled government regulators.
While they haven’t directly ordered us to buy low-cost passives, the effect has been similar. They’ve engineered this by tilting the table towards the lowest-cost passives, as they’ve decided this is in consumers’ best interests (like America’s Pension Protection Act of 2006, which served to push pensions into default passive options).
11. I tip my hat to the early backers of index funds, they were classic rebels. Jack Bogle was screwing Wall Street’s lucrative model when he set up Vanguard in the 1970s, while advisers who were early to switch to the passive model in the 2000s were also bravely rejecting the established active-buying mainstream.
But with passive now the majority, have those roles reversed? Is a young adviser putting clients into passives today ‘sticking it to the man’? Or just blindly following the herd?
That’s a rhetorical question; of course it’s the latter. Passivists rejoice! The revolution is over! You’re officially in charge.
Now, what are your plans for leading the market?
12. If active is a shrinking minority, and passive is, well, passive, who’s actually driving the bus?
In terms of volume of trades, professional stock pickers are an even smaller minority than that 54% passive stat implies. According to CBOE, having been 80% of trades in the 1990s, active’s share is down to just 10%. In other words, they’re not driving anymore.
Who is then?
I wrote about market dynamics a couple of columns ago (Google ‘Playing the Gamma Knife Market’). They’re more complex than just ‘everyone is buying the S&P500’. But to summarise; it’s a combination of index buyers and momentum traders (who buy what’s going up and sell what’s going down — regardless of fundamentals), with only a dash of professional stock pickers — the ones who are actually reading reports and accounts.
This was not Jack Bogle’s original plan for index funds. They were designed to work as a small minority that would piggyback off the research carried out professional stock pickers who, back then, made up all of the market.
13. Long story short; the move to passive has driven money into large caps and out of small caps. As a result, the average small cap looks outstandingly good value, while large caps appear increasingly expensive.
This is creating an ‘Active Trap’. Enticed by what are obviously more appealing fundamentals, active investors move into small caps. But their move doesn’t outweigh the money that’s abandoning active funds for passives, which means money flows are, on balance, still bolstering large caps and dragging down small caps. So active fund performance continues to worsen, which leads more people to abandon them — another pernicious feedback loop.
14. Beyond the stats, there’s plenty of anecdotal evidence that investment decisions are no longer being made by professional stock pickers.
For example; consolidation of advisers and wealth managers is rampant. Increasingly, the standard consolidator model is to give clients a centrally managed portfolio of low-cost index funds.
This business decision makes perfect sense to a CEO, as their rearview mirror shows better returns at a lower cost (and therefore higher margins). But it’s still a business decision, not an investment decision.
I spoke with an active manager last week who’s had £50m pulled from their £100m fund by a large wealth firm. This was mandated by the firm’s senior management and was against the advice of their own fund analyst. It’s therefore the CEO that’s moving the market, not the investment professional (this is a common turn of events). Again; this isn’t what Jack Bogle envisaged back in 1975.
15. I used to think a higher weight of passive investors, who aren’t analysing stocks, would make the market less efficient, and therefore easier for active managers. And then I remembered Darwinism. Doh! Survival of the fittest should mean it’s the weakest stock pickers who are killed off, making the market more efficient, not less.
But, looking at conditions today, I’ve changed my mind again. The most active fund managers are being out-survived by those who have cuddled up to the benchmark. Which means Darwinism is now killing off the best long-term stock pickers, because allocators’ disdain means the truly active can no longer survive their inevitable bouts of short-term underperformance.
16. On a professional level I feel the pressure to do as I’m told by the market, the press, and the regulator by dumping my active funds and buying passives. Underperforming is no fun, and my inner chimp would rather I joined the herd than stay out in the cold. I counter this impulse by playing Rage Against the Machine’s Killing in the Name of at high volume on my drive in.
On a personal level I feel zero desire to join the passive herd, as my rational brain can see there’s no good investment reason for doing so. When it comes to our funds (in which I’m heavily invested), my rational brain outvotes my inner chimp, aided by rules we created at the outset for exactly this scenario. We know our role is to provide an alternative for those who don’t want to play the passive game, and we’re not going to change.
17. Some active funds are still winning, however. We own a few of them. These tend to share two traits: They’re focused on large caps and their style is flavour of the month. If they don’t have both traits, they’re probably struggling. If they have neither, it’s been brutal, no matter how good they are.
18. It’s a matter of speculation what happens to markets as the passive majority grows. It’s hard to imagine it will be anything good though.
This video by Mike Green is proving popular among active investors. Naturally they’re biased, but what he describes chimes with the increasingly illogical action they’re seeing in day-to-day market movements.
He suggests the breaking point is somewhere between here and an upper limit of 83% passive for the market (this sounds too precise for my liking, but I agree with the principle). As we approach that limit, Green suggests volatility will rise to unnatural levels, eventually resulting in repeated 1987-style collapses, triggering circuit breakers that close the market.
This sounds about right: If passive investors start selling instead of buying, and the momentum investors jump on that trend, there simply aren’t enough active investors left to buy the stocks the index investors are selling (even if they wanted to, which they generally don’t). It’s not hard to imagine the market gapping down sharply if this sparks panic, particularly among close-to-retirement baby boomers.
19. But don’t worry, if we have brave, imaginative, forward-thinking regulators, they will already be on top of this risk and will take pre-emptive measures to ensure this breakdown doesn’t occur.
Do you think we have brave, imaginative, forward-thinking regulators?
20. Using index funds as the basis of your wealth business model reminds me of James C. Scott’s ‘Parable of Scientific Forestry’: In 19th Century Saxony, they hit upon the idea of ‘managing’ forests to eke out more timber from the available land. Out went random, organic forests, and in came monocrops — nothing but neat rows of huge, single-species trees of the same age.
This increased yields for a while and lowered management costs. But after a couple of rotations, yields collapsed as the monocrop destroyed fertility, biodiversity and resilience, which led to pests, disease and storm damage.
The current rush to embrace the index at the expense of everything else has uncomfortable undertones of monocropping, in particular its disregard for smaller, less liquid parts of our market ecosystem. These perform important economic and social functions, but we are crushing them in our clamber for ever cheaper investment products.
21. Deeper into the realms of speculation, what might happen if we do reach this passive collapse?
In the short term we’ll have to close the market, as we previously have in times of emergency. It will then be hard to reopen, as investors will be queueing up to redeem, leading to more steep falls and further market closures.
How do they reopen again? The government might use taxpayer or QE-created money to buy out investors, despite this being an uncomfortably anti-capitalist thing to do. Or they could seek ways to disperse investors away from the index, perhaps using taxation or outright banning of index-based investing. This would take a while to fix.
22. What on earth is the playbook for investing in a market that might suddenly close for an unknown amount of time?
If in doubt, resort to a Warren Buffett quote:
“I buy on the assumption that they could close the market the next day and not reopen it for five years.”
Have you checked all the stocks in your portfolio? Do they pass Warren’s simple test? In a market failure, this might suddenly become important again.
This piece was first published in Citywire Magazine in April 2026.
