For well over a decade now, those taking a passive approach to investing have enjoyed a trifecta win of low costs, access to world-leading companies and strong performance. At the same time they have ducked any involvement in the tricky process of identifying good active managers – and yet there are now signs investors’ views are changing on the merits of passive funds in the current environment.
As regular Wealthwise contributor Andy Parsons has highlighted in recent columns, the strength of passive has fed through into MPS solutions. While direct comparisons are difficult, in general there has been little advantage to investing in an active portfolio for the most cautious investors – and often an active disadvantage in higher growth portfolios.
Defaqto data shows that for cautious, balanced and growth peer groups, passive MPS options have outperformed their active counterparts over five years: 24.2% versus 21.1% for cautious, 33.3% versus 27.8% for balanced, and 45.5% versus 31.5% for growth. For adventurous portfolios over this time period, there is gap of more than 20 percentage points.
For multi-asset funds, the picture is more mixed – pun not initially intended – with passive funds weaker over five years in the mixed investment 20-60% shares category, but outperforming in the 0-35% and 40-85% fund groupings.
Passive’s virtuous circle
Active managers have been left battling against the tide. According to Investment Association (IA) data, passive funds have gone from 11.3% of total assets under management in the UK in 2015 to 25.8% in 2024. In this time, a virtuous circle has taken shape across most major markets: money has flowed to passive funds, supporting the share prices of the world’s largest companies, which has boosted performance, in turn seeing more capital flow to passive funds.
Calling an end to this has generally been a fool’s errand. Yet the latest IA data shows changes may be afoot. Net tracker funds inflows were £233m in November – low for their history – while active funds recorded their highest net inflow in six months, at £297m.
Among UK equity funds, active funds outpaced passive funds by £52m. To put this in some context, active funds have seen negative outflows every year since 2018 and this is the first month they have beaten passive funds since for over a year. LSEG data for November showed a similar pattern with active funds seeing inflows of £856bn as passives attracted £422m.
“In past cycles, the final stages were marked by frenzied retail investors buying shares from institutional holders – who were tiptoeing towards the exits – and that is beginning to happen again today.
History suggests no single investment style outperforms indefinitely and the dominance of passive now seems extreme.”
While acknowledging this could of course be a one-off, prompted by ongoing nervousness around the AI trade, there are reasons to believe the tide could turn more strongly in favour of active options.
The first is just one of cyclicality – history suggests no single investment style outperforms indefinitely and the dominance of passive now seems extreme. AJ Bell’s most recent ‘Manager versus Machine’ report shows just 24% of active funds have beaten a comparable index tracker over 10 years – the worst reading since it began the analysis in 2021.
In that first report, 56% of active managers in the study outperformed a comparable index fund over 10 years. Furthermore, 85% of UK active funds outperformed their passive counterparts, compared with just 16% in the most recent study.
There are a number of ways active could outperform from here. Market leadership could tilt away from the US while investors could fall out of love with the AI trade or, as discussed in this week’s Monday Club, they could rediscover the attractions of smaller companies. All could prompt a shift in the balance between active and passive.
Cracks in the US trade
There are already cracks in the US trade. For UK investors, high weightings to the US did not work especially well in 2025 – indeed, if they were unhedged, they would have lost on the dollar, receiving just 3.9% from an S&P 500 tracker.
That compares with the 25.8% for the FTSE 100, 20.4% for the MSCI Europe and 33% for MSCI Asia excluding Japan indices. If an investor had stuck to MSCI World-style country weightings, therefore, they would have had a tough year. At the very least, this argues for a more diversified asset allocation than that offered by many passive portfolios.
For the most part, though, markets have still been concentrated in largecap stocks across the world, so it has still made sense to be in passive as long as investors were geographically diversified. In the UK, the market was led by Rolls-Royce, miner Fresnillo and the large banking groups. In Asia, TSMC and Samsung dominated. Europe has been the exception, where southern European markets have led performance.
Could this change too in the year ahead? For that to happen, investors really would need to fall out of love with the AI trade. Although there is a lot of talk about a bubble bursting, a slow deflation may be more likely. The ‘Mag7’ giants have trailed since the start of 2026 and only two – Alphabet and Nvidia – outperformed the S&P 500 in 2025.
Some parts of the market – most obviously the US mega-caps – look worryingly expensive. Just about everything else, however, ranges from ‘fine’ to ‘once-in-a-generation cheap’.”
Factset data suggests the grouping are losing their advantage over the rest of the market on earnings. In the fourth quarter of 2025, for example, year-on-year earnings growth for the Mag7 was 20.3%, compared with 4.1% for the rest of the market. Looking forward, however, the Mag7 earnings growth is set to be 22.8%, while for the other 493 S&P 500 companies, it is expected to be 12.1%. This narrowing is not yet reflected in relative valuations.
“My concern stems from high valuations in certain areas, with mega-cap US growth stocks central to that,” says Simon Evan-Cook, manager of the Downing Fox multi-asset fund range. “And, as these now make up a massive part of the global market, you can extend my concern to the market cap-weighted index that is tracked by passive products.
“Are we near a peak? My gut still says there is a way to go but it does at least feel like we are entering the final stage. In past cycles, the final stages were marked by frenzied retail investors buying shares from institutional holders – who were tiptoeing towards the exits – and that is beginning to happen again today.
“Some parts of the market – most obviously the US mega-caps – look worryingly expensive. Just about everything else, however, ranges from ‘fine’ to ‘once-in-a-generation cheap’ – for example, many smallcap markets.” To date, investors have largely overlooked the better value on offer elsewhere.
Actively identify opportunities
To Evan-Cook’s mind, “it is really not that hard to find great opportunities” – but he continues: “‘Find’ is the key word here. You will need to actively identify these opportunities as you cannot rely on a classic market tracker doing it for you.” Should history repeat itself, he believes, anyone invested in a global tracker – or anything resembling one – could go 10 years without making money.
Again, there are reasons why investors may start to look elsewhere. In the US, a combination of lower interest rates and tax cuts included the Big Beautiful Bill could help to support domestic companies and thus mid and smallcap stocks.
These have already started to power ahead since the start of the year. Funds in the North American Smaller Companies sector are up by an average of 4.1% in 2026. In the UK, investors are finally starting to reappraise smallcaps as well, with the sector up an average of 5.2% this year. Interest rate cuts and lower bond yields should support this.
In the current market, the index is highly concentrated in just a few companies and, as more money from investors via their pensions and ISAs moves into the market, the prices of these companies’ shares are rising.”
Against this backdrop, active has a real chance to reassert itself. “It must also be understood the manufacturers of passive investment have an interest in selling something cheap,” observes James Scott-Hopkins, founder at EXE Capital Management. “It is a compelling argument, particularly when so many active managers underperform.
“They make money from selling their products – but beware of going cheap. In the current market, the index is highly concentrated in just a few companies and, as more money from investors via their pensions and ISAs moves into the market, the prices of these companies’ shares are rising. It may be doing so based on supply and demand rather than fundamentals. If everyone chases a limited number of shares, this is bound to happen. And if the market turns for whatever reason, investors fall with it. It is all or nothing.”
Arguing the environment is turning to favour active products, Scott-Hopkins offers the example of three of his favourite investment trusts: AVI Global, Fidelity Special Values and Law Debenture. “In the first decade of this century, the S&P 500 index returned just 1.29%, including dividends, and adjusted for sterling,” he continues.
Portfolio stability
“Over the same period, the MSCI World returned 12.27% and the FTSE All-Share 34.79%. Not startling – indeed, this was known as the ‘lost decade’ for equity markets. For its part, though, AVI Global, which has a low exposure to the US and AI, returned 272.43%. Fidelity did even better, at 276.16%, and it only invests in UK-listed firms. The same is true of Law Debenture, which made 171.03%.
“Then, if we take the post-recession period from January 2010 to the end of last year, when markets recovered, the position is altered – primarily due to the Mag7 and the unusual period of very low interest rates. The S&P 500 returned 809% and the MSCI 509%. Law Debenture still outperformed the MSCI, with Fidelity not far off at 446.35%, but AVI suffered from the absence of AI at 325%. Over the full 25-year period, however, all three trusts produced around double the return of the S&P 500.”
The world is changing. Interest rates are closer to historical norms but inflation is far from tamed, bond markets are jittery amid profligate government spending and geopolitical tensions are everywhere. This could well turn out to be an environment where good stockpickers prove invaluable for portfolio stability. Investors may be starting to realise that already.
