Due in part to the rise of exchange-traded funds (ETFs) and target date funds, there’s been a significant shift away from active to passive (aka index) investing which seeks to replicate the performance of a specific market index. With passive funds now comprising around 50% of equity assets and 30% of fixed income assets, it’s evident that investors have waning confidence in the skills of active fund managers to outperform a particular benchmark or market index through stock-picking, market timing, and asset allocation.
For example, while China’s equity market rebounded in 2024 after a difficult stretch, active managers struggled to keep pace with large passive products.
According to the latest Morningstar Active/Passive Barometer reports for China and Europe, only 13.4% of China’s stock-heavy funds managed to outperform passive peers, a sharp decline from the previous year.
While actively managed large-growth funds in China fared the worst, with only 9.7% beating the average passive return, small- and mid-cap active managers performed better, with 38.2% outperforming.
By comparison, across 38 equity categories in the UK, active managers’ weighted average one-year success rate stood at 29.0% in June 2025, almost unchanged from 28.8% at the end of 2024.
While the UK large-cap category stood out as a relative bright spot, with 46.5% of active managers outperforming in the past year, up from 42.1% a year earlier, long-term success dropped to 11.0% over 10 years.
Global government bond managers thrive
Interestingly, while active fund managers struggled to justify the fees they charge, global government bond managers thrived.
The decision by global government bond managers to exploit relative value trades to realign the geographical exposure away from the United States dollar may explain why their one-year success rate of 69.8% in June was up from 52.0% a year ago.
What recent investment trends point to, argues Steve Boothe, Head of Global Investment Grade Credit at T. Rowe Price, is that passive investment flows are arguably changing markets.
While around half of the equity investment flow goes into some form of a passive product, Boothe suspects this number is undercooked, given that it fails to account for things like futures, total return swaps, etc.
“The reality is that the marginal dollar coming into markets is passive,” says Boothe.
“I think what might be a little underappreciated here is the hand-in-hand relationship of the ETF ecosystem and passive investment."
Based on T. Rowe Price’s numbers, there’s around US$8 trillion in global ETFs, $7 trillion in the U.S. and $6 trillion is within a passive framework.
Passive investing linked to US labour market
In the U.S., Boothe reminds investors that there’s an increasing link between passive investing and the labour market.
Within the U.S., the most popular retirement savings vehicle is a product known as a target date product. Of the US$12 trillion in 401(k) or retirement saving assets, four of that is via a target date product.
Guess how much of that is passive? A whopping 50%.
Duration exiting credit markets
Boothe also reminds the market that when it invests in a passive product, it’s investing in a concentrated vehicle.
“It is pretty obvious. And the bond market? I’m going to speculate here a little bit because we don’t quite have this concentrated nature in our market yet,” Boothe noted.
“A growing concern that I have is, and you’re starting to see this trend surface coming out in 2022, there’s duration coming out of credit markets.”
What Boothe is observing is that issuers are increasingly issuing in the front end of the curve, which is where passive flow exists.
As passive ETFs grow, Boothe is witnessing the liquidity premium come out of credit indices.
“I think there’s a direct linkage here. As more and more flow comes into the market via a passive structure, liquidity premium comes out,” he says.
“You want to know why private investment-grade credit is so popular right now? This is why. So there’s a connection here between passive investing and private credit.”
More to passive investing than lower fees
Contrary to popular opinion, Boothe claims there’s a lot more to passive investment than simply offering market access at lower fees.
He argues that passive investment is increasingly becoming a core backbone of a lot of products and how dealers hedge their books.
That said, Boothe attempts to describe the fuller gamut of passive investing that the market typically overlooks.
He outlined three ways passive investing behaves differently from its active counterpart:
- Passive doesn’t hold cash: It’s hard to replicate an index if you’re holding cash.
- Flows: As I alluded to earlier, you must trade. An active manager, if I have it in flow, I have an option. I could hold cash. I could buy components of a portfolio that are a little cheaper. There’s a lot of things I could do. I had options. Passive does not.
- Fundamentals. It doesn’t matter. We’re going to buy. We have to buy. We have to follow our index construction, which is the last bullet here. We active managers tend to view the benchmark as an opportunity cost.
Why does this matter?
Boothe reminds investors that if you’re given money and forced to buy assets at any price put in front of you, the asset price is going to go up.
He claims that forced buyers are going to have an outsized impact on markets.
“As an active investor, when I enter the market to trade, I proactively try not to disturb the market. As a credit investor, this is incredibly difficult,” says Boothe.
“The punchline here is markets are becoming increasingly inelastic and what that means is that they’re much more sensitive to flows. So as flows come in, it has a bigger impact on price.”
The bottom line, concludes Boothe, is that passive flows are making the market less elastic, more sensitive to flows and can also mechanically inflate asset prices.
He says the onus is now on active managers to adapt to this framework, change how they think about managing portfolios and risk, while potentially capitalising on an increasingly inelastic market.
Where does that leave risk premiums?
Within credit markets, Boothe is witnessing greater distortions within the higher quality segment of credit relative to lower-rated levered credit.
He is also witnessing equity premium coming out of high-quality credit markets.
It’s the larger cap, debt-loaded companies, adds Boothe, where equity premium is being squeezed due to them receiving the mechanical natural buy-in from the passive framework.
“So, you’re seeing large data cap companies, like Apple, the equity premium just gradually squeezes,” says Boothe.
“The other end of the credit spectrum… you’re seeing the inverse as segments of the credit market increasingly get left behind, as they’re not a large part of an index or they’re increasingly not getting a focus of that mechanical bid, there’s growing equity risk premium.”
