06/06/2026
Are Passive Funds Creating a New Investment Risk?
For much of the past fifteen years, passive investing has been one of the great success stories of financial markets.
Low costs, broad diversification, and strong market returns have made index-tracking funds the default choice for many investors, pension providers and financial institutions.
But as financial advisers, our job is not to focus on what worked yesterday. It is to ask what risks may lie ahead.
Increasingly, I find myself concerned that many investors do not fully understand the risks that can develop when too much money follows the same strategy.
- How Passive Funds Work
Passive funds typically track a market index such as:
* S&P 500
* Nasdaq 100
* Euro Stoxx 50
* FTSE 100
* Nikkei 225
Rather than selecting companies based on valuation, profitability, balance sheet strength or future prospects, passive funds simply buy companies in proportion to their size within the index.
The larger the company becomes, the more money flows into it.
This creates a self-reinforcing cycle.
As a company's market value rises, passive funds buy more of it. As passive funds buy more of it, the share price can rise further.
In rising markets, this can work very well.
In more challenging market conditions, the picture becomes less straightforward.
- The Concentration Problem
One of the biggest risks today is concentration.
According to a recent Financial Times commercial feature produced in partnership with AllianceBernstein, by the end of 2025 the ten largest companies represented more than 40% of the market capitalisation of the S&P 500.
As Morgan Stanley Wealth Management CIO Lisa Shalett noted:
"The higher the index gets, the more fragile it becomes."
She further observed:
"While a bank may report a phenomenally good quarter, that may not matter at all, compared with what happens if an Nvidia misses their number by one penny."
Many investors believe they own hundreds of companies. In reality, a significant portion of their portfolio performance may depend on a handful of technology stocks.
- The Old Rules May No Longer Apply
For decades, investors were taught that a portfolio containing roughly 60% equities and 40% bonds provided a sensible balance between growth and stability.
The theory was simple:
* Equities generated long-term growth.
* Bonds helped protect investors when stock markets fell.
However, inflation has changed the landscape.
The key driver today is no longer simply economic growth. It is inflation, interest rates, government borrowing, geopolitical tensions and energy security.
- Why Investors Need to Look Beyond Labels
Traditionally, investors thought in terms of asset classes:
* Equities
* Bonds
* Property
* Cash
The challenge today is that two investments carrying different labels can still be exposed to the same underlying risks.
A technology stock and a long-dated government bond may both suffer if inflation expectations rise.
This is why modern portfolio construction increasingly focuses on identifying risk drivers rather than simply counting asset classes.
The objective is not merely to own different investments.
The objective is to own investments that respond differently when economic conditions change.
- Active Management Has a Role to Play
This does not mean passive investing is wrong.
Far from it.
Passive funds remain a highly effective and low-cost way of accessing global markets.
However, I believe many investors have become overly reliant on them.
There are periods when active fund managers can add value by:
* Reducing exposure to overvalued sectors.
* Increasing exposure to undervalued opportunities.
* Managing risk during periods of heightened volatility.
* Adjusting bond exposure as interest-rate conditions change.
Passive funds cannot make those decisions.
They simply follow the index.
If markets become increasingly concentrated and volatile, active management may once again become an important component of portfolio construction.
- The Bigger Question
Investors should not ask whether passive investing is good or bad.
The more important question is:
**Do I fully understand the risks I am taking?**
Many investors believe they are diversified because they own a passive global equity fund and a bond fund.
In reality, they may have significant exposure to the same economic forces driving both markets.
As advisers, our role is not to predict the future.
It is to ensure that clients are prepared for multiple possible futures.
The investment environment of the last fifteen years has been unusually favourable for passive investing.
The next fifteen years may look very different.
That is why understanding risk matters just as much as pursuing returns.
*Source: Financial Times Commercial Department in partnership with AllianceBernstein, "Why the 60/40 portfolio split is no longer fit for purpose."*
