‘Passive’ investing has one of the best marketing departments in finance. The word has become synonymous with humility, discipline and monk-like restraint. Do nothing, pay less and let markets do the work; what could possibly go wrong?
Quite a lot, especially once you leave the simplicity of single-asset equity exposure and enter the messier world of balanced, multi-asset portfolios. A passive multi-asset investor is a contradiction in terms.
A selective history of passivity
Passive equity investing rests on a beguilingly simple idea: markets are broadly efficient. Prices reflect publicly available information and trying to outguess them is expensive, futile and, statistically speaking, embarrassing. Better, therefore, to own the market and move on with your life.
This logic has a respectable intellectual and practical lineage, but it is worth remembering what passive vehicles actually do. They accept prices, replicate indices constructed elsewhere, using rules that embed biases about liquidity, size, geography and corporate structure.
In that sense, passive strategies are not neutral observers, they are economic free-riders (parasites, to use the biological metaphor) living off the genuine price discovery generated by active, risk-bearing market participants. No active investors, no efficient prices. No efficient prices, no sensible index to track.
Any robust system can tolerate freeloaders to a degree. The problem arises when the parasite population grows too large
Of course, any robust system can tolerate freeloaders to a degree. The problem arises when the parasite population grows too large.
When price-indifferent capital dominates
Markets are robust, but not infinitely so. If too much capital becomes price-indifferent (buying and selling solely to track an index), this starts to have a self-fulfilling impact and prices can drift away from fundamentals. Liquidity becomes conditional, correlations rise and risk is merely masked by diversification.
Space X, Open AI and Anthropic seem set to exploit this dynamic by raising more than the ~$470bn raised by the US IPO Market from 2016 to 2025.
The S&P, Nasdaq and FTSE Russell are considering a ‘fast-track’ to allow these companies into prominent indices, such that indiscriminate funding is all-but guaranteed. In fact, if the top ten venture backed companies list at current prices, they would represent ~4.5% of the S&P 500!
The risk is not that passive investing suddenly ‘fails’, but that it quietly accumulates hidden fragilities
We have seen this movie before – a recent example from a different market is central banks’ extensive and indiscriminate government bond purchases.
These were not passive in the same sense, but they were price-insensitive and significantly distorted passive bond indices themselves, resulting in distorted yield curves, suppressed risk premia and a painful repricing when the music stopped.
The same dynamic exists in heavily indexed markets. For the average investor, the risk is not that passive investing suddenly ‘fails’, but that it quietly accumulates hidden fragilities that only reveal themselves when conditions change.
Passivity’s original sin
In multi-asset investing, the idea of ‘passive’ collapses immediately as the moment you choose a benchmark, you are making an active decision.
Start with equities. Do you adopt a fully global approach, or retain a home bias? Both choices are defensible and lead to materially different outcomes. Do you accept market-capitalisation weights, or worry about the outsized influence of a handful of US mega-cap technology stocks on your risk? You are still making a call, it’s just an implicit one.
Ben Gilbert: Why the ‘best’ multi-asset solution keeps changing
Then consider fixed income, where passivity becomes even harder to sustain. Do UK investors hold only gilts, matching nominal liabilities but accepting the risk of another UK government policy gaffe? Or do they diversify globally and hedge currency exposure?
Market-cap-weighted bond indices allocate the most capital to the most indebted issuers. That is not neutral and is the exact opposite of what a rational lender would seek to do.
Even choosing between MSCI and FTSE Russell methodologies produces different volatility and return outcomes in so-called ‘passive’ multi-asset funds, as anyone who has looked at a simple return-versus-volatility scatter chart will attest.
The alternatives question: unavoidable, not optional
Finally, there is the awkward matter of alternatives. In a world where equity and bond correlations are structurally higher and bonds failed spectacularly as an all-weather ballast in 2022, pretending that a 60/40 portfolio is ‘passive’ borders on nostalgic fiction.
There may be such a thing as passive in theory, but for balanced investors there never was
Should balanced investors allocate to alternatives at all? If so, which ones? How liquid? How transparent? What size? These are not questions that an index can definitively answer. They require judgement, experience and a willingness to adapt as market structure evolves.
Doing nothing is still a decision, just not a very robust one.
What balanced investors need
The truth is balanced investing has always been active at its core. Asset allocation, risk budgeting, benchmark selection and rebalancing rules drive a material proportion of long-term outcomes. Costs matter, but discipline matters more. Neither eliminates the need for prudent decision-making today in the face of an uncertain future.
What balanced investors need is not the illusion of neutral passivity, but a seasoned asset allocator with a clear, transparent and adaptable process. One that acknowledges the lessons of the past but recognises when this is no longer a reliable guide to the future.
Over decades of managing diversified multi-asset portfolios, the priority has never been on defending a static framework, but on ensuring portfolios remain fit for the world investors inhabit today. There may be such a thing as passive in theory, but for balanced investors there never was.
Ben Gilbert is MPS portfolio manager at Sarasin & Partners
