This article was issued and approved by Square Mile Investment Services Limited which is registered in England and Wales (08743370) and is authorised and regulated by the Financial Conduct Authority.

During much of the 2010s and early 2020s, broad-market indices delivered strong, relatively uniform returns. While active investors could (and often did) make good returns in that time, this backdrop was great news for passive strategies. Those strong market returns were a highly effective way for passive investors to grow their wealth in a cost-efficient way.

But, as we enter 2026, markets are becoming more complex, more uneven and more volatile. The backdrop of low inflation and ultra-low interest rates, which meant markets could rise evenly, has disappeared. Simply owning the market may no longer be enough.

So, while passive investing can still be appropriate for some in certain circumstances, others may want to reconsider whether a fully passive approach is the best strategy for them.

Key takeaways

1) Higher interest rates and higher inflation alongside tighter liquidity have widened the gap between winners and losers in the market - an environment which can favour skilled, active stock selectors.

2) Market-cap-weighted indices have become increasingly dominated by a small group of names, creating concentration risk that could more acutely affect passive investors.

3) Current levels of volatility and stretched valuations create both risk and opportunity. Active investors can mitigate risk more easily, while also being well placed to take advantage of any opportunities.

Market conditions are becoming uneven

Over the last 15 years, the benefits of active management and stock selection were arguably harder to realise. Thanks to the loose monetary policy and ample liquidity experienced for much of that time, markets became synchronised, narrowing the gap between winners and losers. Hence why passive investing could be so effective.

Today, that’s different.

The current environment of higher interest rates and tighter liquidity has increased dispersion between those winners and losers. The tighter financial conditions mean that economically unviable businesses are increasingly unable to survive. Furthermore, global economic growth is also less synchronised, while political and geopolitical risks are more elevated. The resulting greater dispersion creates more opportunity for skilled active managers to add value through stock selection and sector rotation, something passive funds cannot do.

The ultra-low-rate environment also meant that bonds offered little income, while cash delivered negligible returns. Now, though, with central bank rates higher across the board, bonds offer better yields, cash has become a more competitive asset class and equity risk premia may be more volatile. In this environment, active asset allocation across equities, bonds and alternatives can potentially improve risk-adjusted returns relative to a static, passive mix.

Market concentration is an increasing factor for passive investors

Another reason passive investing may not be as powerful a tool as it once was is the current level of market concentration. As market-capitalisation-weighted indices allocate more capital to companies whose share prices have already risen the most, global equity benchmarks have become increasingly dominated by large technology and AI-linked firms in recent years.

While the growth and valuation of these firms have been extraordinary, that growth has come at the expense of diversification. It means that passive investors are automatically reliant on a narrower set of outcomes, so if sentiment or fundamentals were to deteriorate, they would be adversely affected in an exponential way.

Concentration risk is therefore a clear and present danger. The alternative of utilising an active or blended approach makes it possible to limit exposure to overheated stocks, tilt towards under-represented or undervalued areas and reduce reliance on a small group of mega-cap names.

Valuations look stretched in key parts of the market

One benefit of passive investing is remaining fully invested, which can help improve efficiency. However, in some instances, it can be a drawback. Arguably, we are experiencing that now.

At the end of 2025, valuations in particular sectors (especially US large-cap growth and AI-related stocks) appeared more demanding relative to long-term averages. It meant that passive investors continued to allocate capital to expensive areas simply because they were large index constituents. By contrast, an active manager could reduce exposure when valuations appear excessive and reallocate to better risk-reward opportunities.

Plus, passive strategies are inherently “backwards-looking”. Index construction is based on past market capitalisation, not future prospects. As a result, passive investors naturally own more of what has already risen and fewer names that are emerging opportunities. In fact, emerging opportunities only enter indices after they have grown large enough and often after much of the upside has already occurred.

On the flip side, active management can be more forward-looking, positioning portfolios before changes are fully reflected in index weights.

Volatility creates opportunity

Another downside to passive investing is an investor’s inability to exploit the opportunities volatility can provide. Active managers, on the other hand, can use volatility to their advantage as it allows them to rebalance tactically, add downside protection and identify highly attractive entry points created by forced selling or overreactions.

We are already seeing examples of market stress that have led to such forced selling as well as sharp style rotations and valuation dislocations. For instance, there are more frequent shifts between growth and value, between large and small companies, and between US and international markets.

Moreover, active risk management can help reduce volatility and protect capital during downturns, in a way that passive strategies cannot. To do so, understanding where we are in market cycles is crucial. We’re currently moving deeper into a mature market. At this juncture, this means:

● Drawdowns can be sharper.

● Correlations can rise during stress periods.

● Markets can become more volatile.

While all these factors can be useful or mitigated by the active investor, they can be particularly troublesome for the passive investor.

So, what now?

It’s crucial to remember that passive investing is highly effective in broad, efficient, steadily rising markets. Active management tends to be more valuable in complex, volatile and uneven market environments, which increasingly appears to be the case in the year ahead. Moving to a blended or active approach can therefore be seen as a risk management and opportunity-seeking decision, rather than a rejection of passive investing.

So, despite the shift in the market backdrop since the early 2020s, there isn’t an automatic need to abandon passive investing altogether. Instead, blended or core-satellite approaches can offer a practical middle ground. Utilising such strategies involves investing in some low-cost passive funds for broad market exposure while combining those investments with active management in areas where markets are less efficient, such as smaller companies, emerging markets, credit or in themes which can potentially add value.

Bearing this in mind, at Titan Square Mile, we continue to maintain our approach of staying invested, being broadly diversified and avoiding decisions based on short-term noise. Within this framework, we feel that combining passive investments with selective active management can enhance diversification, manage risk and identify opportunities where markets are less efficient. Ultimately, we believe that passive investing still has a place, but (as with all investment strategies) only for the right investor, in the right circumstances.

This document is marketing material issued and approved by Square Mile Investment Services Limited ("SMIS") which is registered in England and Wales (08743370) and is authorised and regulated by the Financial Conduct Authority. The independent research is provided by Square Mile Investment Consulting and Research Limited ("SMICR") which is not authorised or regulated by the Financial Conduct Authority and does not undertake regulated activities. Titan Square Mile is a trading style of SMIS and SMICR. SMIS and SMICR are wholly owned subsidiaries of Titan Wealth Holdings Limited (Registered Address: 101 Wigmore Street, London, W1U 1QU).

This document is aimed at professional advisers and regulated firms only and should not be passed on to or relied upon by any other persons. It is not intended for retail investors, who should obtain professional or specialist advice before taking, or refraining from, any action on the basis of this document. It is published by, and remains the copyright of, SMIS. SMIS makes no warranties or representations regarding the accuracy or completeness of the information contained herein. This information represents the views and forecasts of SMIS at the date of issue but may be subject to change without reference or notification to you. This document does not constitute investment advice, a recommendation regarding investments or financial advice in any way and shall not constitute a regulated activity for the purposes of the Financial Services and Markets Act 2000. Should you undertake any investment activity based on information contained herein, you do so entirely at your own risk and SMIS shall have no liability whatsoever for any loss, damage, costs or expenses incurred or suffered by you as a result. SMIS does not accept any responsibility for errors, inaccuracies, omissions, or any inconsistencies herein. Past performance is not an indication of future performance.

Date: December 2025