Passive vs Active: Why It’s Time to Stop Choosing Sides

I recently came across a post on LinkedIn that struck a chord. It read:

“I think X, and if you think Y, you’re an idiot.”

That sort of tone seems to be the norm these days — binary thinking, polarised views, and little room for nuance. It’s especially common in investment circles, where the debate between passive and active strategies often descends into tribal loyalty rather than thoughtful discussion.

I’ll be upfront: My previous firm was built on a foundation of active investment management. We conducted deep research, carefully selected managers, and measured our performance against meaningful benchmarks. In many cases, we outperformed those benchmarks. But it wasn’t always perfect. We made mistakes, and success took time, effort, and continuous due diligence.

This experience taught me that true investment discipline doesn’t lie in choosing sides. Active and passive approaches don’t have to compete. Used thoughtfully, they can complement each other, often creating a stronger, more resilient portfolio.

The Case for Passive Investing

The arguments in favour of passive investing are well-established and consistent:

Consistent Underperformance of Active Managers

The S&P Dow Jones SPIVA reports (Standard & Poor’s Indices Versus Active) frequently show that most active fund managers fail to outperform their benchmarks over long periods — particularly in large-cap developed markets like the US and UK.

• Over 10 years, over 85% of US large-cap active funds underperformed the S&P 500 after fees.

• In the UK, around 75% of active UK equity funds underperformed the S&P United Kingdom BMI over the same timeframe (SPIVA Europe Year-End 2023).

Lower Costs, Higher Net Returns

Passive funds tend to charge significantly lower fees (often 0.05% to 0.30%) compared to active funds (0.75% or more). These cost savings compound over time and boost net returns, especially when performance differences are marginal.

Transparency and Predictability

Index strategies follow transparent, rules-based methodologies. Investors know what they’re getting — there’s no style drift, no star manager risk, and portfolio holdings are typically disclosed regularly. That’s reassuring for clients and planners alike.

But the Debate Isn’t That Simple

Despite the strength of the passive argument, it would be naive to assume it’s the right answer in every situation. Here’s why:

SPIVA Doesn’t Cover the Whole Picture

While SPIVA is valuable, it often reflects the most efficient markets — where outperformance is hardest. But in less efficient areas like:

• Small and mid-sized companies

• Emerging markets

• Thematic and specialist sectors 

Active managers have a greater chance to add value through research and selection.

A good example is the IA UK Smaller Companies sector, where the dispersion between top and bottom quartile managers is wide — and outperformance through skill is much more visible.

Risk Management and Capital Preservation

Passive funds generally track market capitalisation-weighted indices, meaning they automatically increase exposure to the most extensive, most expensive stocks — often just as they peak. This creates concentration risk and, arguably, a self-reinforcing cycle.

SEI has noted that blind index investing can amplify market inefficiencies during extremes and has highlighted the importance of tactical allocation to manage downside risk.

Active managers can:

• Reduce exposure to overvalued sectors

• Raise cash when risk signals increase

• Adjust positioning in real-time

During periods of heightened volatility, such as Q1 2020 or 2022’s inflation-driven sell-off, a meaningful proportion of active funds outperformed. According to Morningstar, around 35% of active US equity funds outperformed the S&P 500 over a volatile 12-month period.

Diversification and Tactical Flexibility

Index strategies are inherently market-weighted, often leading to sector or regional concentration (think tech in the US or oil and gas in the UK). Active managers, on the other hand, can diversify away from these biases — or lean into underrepresented areas.

A blended portfolio benefits from both:

• The broad exposure and low cost of index funds

• The selectivity and tactical agility of active funds

The Rub: It's Not About Sides — It's About Suitability

At the heart of all this isn’t the strategy—it’s the client and the environment we’re operating in.

Not all passive strategies are the same. Some are systematic, not strictly passive, with built-in factors or screens. Others are marketed as “index” funds but have active overlays.

Likewise, not all active managers are created equal — and few justify their fees without rigorous evidence.

The risk we face is that the industry—and the investor—chooses passive simply because it’s “easy” or feels safer. This could lead to a false sense of diversification and long-term systemic vulnerabilities.

What’s needed instead is an open-minded, evidence-based approach that combines:

• Active management where it adds value

• Passive exposure where it makes sense

• Systematic strategies that bring precision

  
  

Most of all, thorough research and ongoing oversight ensure everything is still doing its job.

Conclusion

There’s no right or wrong — only appropriate or inappropriate. A thoughtful mix of active and passive investments, tailored to client goals, risk profiles, and time horizons, can improve portfolio outcomes and reduce regret risk.

The key isn’t picking a side — it’s doing the work.