For much of the past 15 years, low-cost passive investing has been difficult to argue against.
It is simple, transparent and cost-effective. It has also delivered strong returns, particularly for investors with exposure to the largest US companies.
I come at this from a slightly different perspective. For many years, I managed portfolios made up primarily of actively managed funds. I believe it is possible to identify good active managers with a clear philosophy, a repeatable process and the discipline to stick to it.
Equally, I would not dismiss passive investing. It can provide efficient and low-cost access to markets and, in my view, has an important role to play within portfolios.
Perhaps the debate should not be about whether active or passive investing is better.
The more useful questions are:
-
What role does each investment play?
-
What risks sit beneath the surface?
-
Is the portfolio genuinely diversified?
-
Are client expectations being shaped too heavily by what has worked recently?
What has driven recent returns?
A relatively small number of large US companies have driven a significant part of global equity market returns.
This matters because many of the most widely used passive funds are weighted according to the size of each company. As a company becomes more valuable, it represents a larger part of the index and, therefore, a larger part of a fund tracking that index.
The ten largest companies represented almost 40% of the S&P 500 by the middle of 2025, a level of concentration not seen since the mid-1960s. Concentration has remained close to these historically high levels during 2026.
This does not mean these are poor companies. Many are highly profitable businesses with strong balance sheets, powerful brands and significant growth opportunities.
It also does not mean their share prices are about to fall.
It simply means that owning hundreds of companies does not necessarily provide the level of diversification we might assume. Diversification by number of holdings is not always the same as diversification by risk.
The influence of low interest rates
There are several reasons why the largest growth companies have performed so strongly.
Innovation, earnings growth and the development of artificial intelligence have all played an important part. However, the period of exceptionally low interest rates also provided a helpful backdrop.
Growth companies are often valued on profits expected many years into the future. When interest rates are very low, those future profits can appear more valuable today. This supported the valuations of many growth businesses and helped concentrate returns within some of the world’s largest companies.
Interest rates are now higher than they were for much of the previous decade, but this does not automatically mean active managers will outperform.
Markets are rarely that simple.
Active management is not automatically the answer
It would be easy to look at today’s market concentration and conclude that active management must now be about to have its moment.
The evidence is more complicated.
Morningstar’s latest Active/Passive Barometer found that 25% of active strategies survived and beat their passive counterparts over the ten years to June 2026. Success rates were lowest among US large-cap equity funds, but were higher in areas including fixed income and property.
For me, this does not prove that active management does not work. It shows that simply choosing an active fund is not enough.
The challenge is identifying managers who may have a genuine advantage, understanding where that advantage comes from and deciding whether it is likely to remain relevant. Costs, capacity, investment discipline and the time given to the manager all matter.
Having spent many years meeting and selecting active managers, I believe good managers can be found. I also recognise that identifying them in advance is more difficult than looking backwards and finding those that have already performed well.
Different tools for different jobs
This is why I believe a blend of active and passive investing can be valuable.
Passive investments may provide:
-
Low-cost access to broad markets
-
Transparency and consistency
-
A useful foundation for a portfolio
-
Less reliance on selecting an individual manager
Active investments may provide:
-
A different approach to markets dominated by a small number of companies
-
Greater flexibility in less efficient areas
-
Access to specialist asset classes or investment ideas
-
A particular focus on income, valuation or risk management
-
The ability to invest differently from the index
This does not mean every portfolio needs a fixed split between active and passive investments. It means using the most appropriate tool for each part of the portfolio.
In some markets, a low-cost tracker may be difficult to improve upon. In others, the construction of the index, the opportunities available or the outcome required may make an active approach more attractive.
Importantly, active and passive investments can still own many of the same companies. Combining the two does not automatically produce diversification. It is the underlying exposures that matter, rather than the labels attached to the funds.
What about future returns?
One sentence I have used previously is:
“If future index returns are lower, or market leadership broadens, client expectations based on the recent past may not be met.”
On reflection, I think there is a danger that this reads as a prediction that index returns will be lower. That is not something we can know.
I would frame it differently:
If market leadership changes or broadens, the experience of the last decade may be a less reliable guide to what comes next.
Future returns may not necessarily be lower. They may simply come from different companies, sectors, styles or asset classes.
This matters because client expectations can easily become anchored to recent experience. If portfolios have benefited from an exceptional period for a relatively small group of companies, we should be careful about assuming that the same pattern will continue indefinitely.
That is not a reason to abandon index investing. It is a reason to think carefully about diversification and the expectations we create.
The real question
I do not believe passive investing is broken, and I do not believe active management provides an automatic solution.
Both can play an important role.
The real question is whether the overall portfolio is built around the client’s objectives and contains a sensible balance of risks, return drivers and investment approaches.
The active-versus-passive debate encourages us to choose a side. Good portfolio construction should be more thoughtful than that.
Perhaps the greatest risk is not selecting active or passive investments. It is assuming that whatever has worked best recently will continue to work in exactly the same way.
Diversification can feel unnecessary when one area of the market is dominating. That is often when it deserves the most attention.
This article is intended for general information and discussion only. It does not represent personal financial advice or a recommendation to use any particular investment strategy or fund. The value of investments can fall as well as rise, and past performance is not a guide to future returns.
Add comment
Comments