What’s Driving the Passive Revolution – And Where It Falls Short

In recent years, passive investing has taken centre stage. According to Morningstar, over 50% of all US equity fund assets were held in passive vehicles in 2023. In the UK, the Investment Association reports that around 25% of assets are now in index funds.

 Over the past two decades, this shift from active to passive investing has been one of the most significant structural changes in the investment world. But what’s driving the change, and where might the passive approach fall short?

Evolving Advice Models

Before diving into the core drivers of the passive revolution, it's worth reflecting on how financial advice has evolved.

Historically, advice was product-focused. Then, it became investment-led. Today, financial planning sits at the heart of advice. Many advisers now recognise that their true value lies not in fund picking, but in helping clients define and achieve long-term goals.

As a result, many are outsourcing investment management. This can naturally lead to a preference for simpler, research-efficient solutions, including passive strategies.

Why Passive Investing Has Gained Ground

Three key factors can largely explain the rise of passive investing:

Cost and Simplicity

Passive funds are significantly cheaper than actively managed funds. In low-return environments, lower fees can make a noticeable difference to overall returns. Investors also appreciate the transparency – they know exactly what they’re investing in, and that the fund is simply tracking a chosen index.

Active Underperformance

Data from SPIVA (S&P Indices Versus Active) consistently shows that most active fund managers fail to outperform their benchmarks over time. For many, this raises a simple question: why pay more for underperformance?

Behavioural Comfort

Passive strategies offer psychological comfort. Investors are increasingly content to "own the market" rather than attempt to beat it, particularly when they understand what they hold and why.

But Is It Game Over for Active Management?

Despite the strength of the passive argument, it's worth noting that only 25% of UK fund assets are held in index-tracking vehicles. There are valid reasons to be cautious about going “all in” on passive investing.

Passive Still Requires Research

Choosing an index fund doesn’t eliminate the need for due diligence. Should you use an ETF or a mutual fund? A pure index or a “smart beta” approach? Not all passive strategies are created equal, and the differences can affect client outcomes.

Concerns Over Market Distortion

An untested but growing concern is that widespread passive investing could lead to market distortions. Because index funds buy and sell based on market capitalisation, not fundamentals, there’s a fear that poorly performing companies may continue to attract capital simply because they’re in the index.

No Downside Protection

Passive strategies track the market, which means they rise and fall with it. In a downturn, there is no mechanism for protection or risk management. Active managers, at least in theory, can move to cash or shift exposure to more defensive assets.

Many investors want their money to reflect their values. While some ESG index funds exist, they often lack the depth, engagement, and customisation of actively managed sustainable funds. For investors who care deeply about sustainability, passive may not go far enough.

Passive Isn’t Perfect – But It Has a Role

It’s easy to highlight the benefits of passive investing without addressing the risks. But just like active management, passive strategies require oversight and context.

Used appropriately, passive funds can form the core of a well-diversified portfolio and complement active strategies that seek alpha in less efficient markets or specialist sectors.

Final Thoughts: Financial Planning Comes First

Perhaps the most important point is this: passive investing is not a substitute for financial planning.

Platforms like Nutmeg, Vanguard and others have made low-cost investing more accessible, but access is not advice. Building a portfolio is only one part of the puzzle. Clients still need guidance around tax planning, retirement income strategies, estate planning, and life goals.

The real debate shouldn't be active vs. passive, but rather how financial planning helps deliver the right outcomes for clients. In that context, both approaches can play a part. Passive investing is not “better”—it’s just different. And like any tool, it’s only effective when used well.