Why Passive Investing May No Longer Be the Dominant Strategy in an Era of Market Volatility
For over a decade, passive and index hugging investing has dominated the financial landscape. The premise was simple and compelling: buy the market at scale, hold it for the long term, keep fees low and reap the rewards. Backed by decades of academic research and a bull market supercharged by cheap money and central bank support, passive investment vehicles such as ETFs and index-tracking funds saw explosive growth. But as we shift into an era marked by rising interest rates, persistent inflation, geopolitical instability and significant market volatility, the assumptions that underpinned passive investing are being challenged. A growing number of investors and fund managers now argue that we may be entering a renaissance period for active management and a return to fundamentals, discernment and strategic positioning.
To understand why active management is regaining appeal, it is first necessary to revisit the forces that propelled passive investing to its dominant global position. Following the Global Financial Crisis, central banks around the world, led by the US Federal Reserve, embarked on unprecedented monetary stimulus. Interest rates were slashed to near-zero levels, liquidity flooded global markets, and asset prices surged. In this low-volatility, high-correlation environment, it has been very difficult for most active managers to outperform broad market indices. Passive strategies, which merely tracked the upward trajectory of markets, appeared smarter, cheaper and more effective than trying to select specific winning stocks that would outperform.
However, with markets no longer moving in sync and being far more volatile, the age of cheap capital is over. With central banks now prioritising inflation control over asset support, volatility has returned. Interest rates have risen and global supply chains remain under pressure post Covid. The geopolitical climate has become increasingly unstable, increasingly so under the new US Administration, with tensions between major powers adding layers of complexity to investment decision-making. In this new environment, active managers are better positioned to navigate volatility and market dislocations, exploit mispricing and manage risk dynamically.
A key shift has occurred in the dispersion of returns. In a bull market, where nearly every sector and stock rises in tandem, picking winners offers little advantage. But in the current environment, the gap between winners and losers is widening significantly. For example, in 2022 and 2023, while broad market indices delivered modest or flat returns, a handful of sectors—particularly energy, defence and selected AI-related tech firms outperformed dramatically, while many others lagged or declined. This divergence creates fertile ground for active managers who can distinguish between overvalued hype and undervalued opportunity.
One illustrative case is the energy sector. For much of the past decade, energy stocks were underweighted or excluded entirely from ESG-conscious passive portfolios. However, the global energy shock following Russia’s invasion of Ukraine triggered a rapid revaluation. Active managers who maintained exposure to fossil fuels based on a valuation discipline, or who rotated into the sector opportunistically, were rewarded handsomely. Passive investors, by contrast, were bound by index weights and constraints that delayed or limited their exposure to the sector’s resurgence.
Another example is the emergence of artificial intelligence as a transformative theme. While large-cap tech names like Nvidia, Microsoft and Alphabet see significant inflows from passive funds due to their high index weighting, the real opportunity for alpha generation lies in identifying under-the-radar companies that will benefit from AI’s proliferation—chip design firms, data centre operators, cybersecurity providers and niche software developers. These are areas where active managers can conduct deep research, engage with management and build high-conviction positions that are not represented in traditional benchmarks.
The Australian markets provide their own case studies. The ASX 200 is heavily weighted towards banks and resource companies, which means passive investors have limited exposure to the next generation of technology, renewable energy and healthcare innovators. An active manager in Australia, however, can construct a portfolio that includes emerging companies in AgTech, MedTech and clean energy sectors expected to drive long-term structural growth. A number of local fund managers have gained recognition for identifying high-growth Australian companies well before they reached index inclusion or broader market attention.
The resurgence of inflation also strengthens the case for active management. Inflation is now higher than it has been for many years. Some industries are facing acute input cost pressures, while others are benefitting from pricing power and demand inelasticity. Navigating this terrain requires a nuanced understanding of balance sheets, supply chains and pricing strategies. Passive funds, by their nature, do not distinguish between inflation winners and losers. Active managers can and increasingly must.
Critics of active management often cite the historical underperformance of most active funds relative to their benchmarks, especially when fees are taken into account. This critique is not without merit. Many active fund managers have struggled to deliver an alpha return and the higher costs associated with active strategies have been a persistent drag. However, the landscape is evolving. Technology has enhanced the analytical capabilities of fund managers, operational costs are falling and the rise of boutique asset managers focused on high-conviction portfolios is challenging the structures of legacy firms. Moreover, investors are becoming more discerning, gravitating toward managers with proven track records of navigating volatility rather than hugging the index and focussing on beta.
Importantly, institutional investors are starting to lead the way in this renewed focus on active investment strategies. Sovereign wealth funds, pension funds and endowments are increasingly adopting new approaches—combining passive core holdings with actively managed satellite strategies to capture upside while protecting downside. For example, Australia’s Future Fund has reduced its passive equity allocations in favour of thematic and actively managed alternatives, especially in sectors exposed to decarbonisation, digital infrastructure and biotechnology.
However, to be clear, the shift toward active management is not a wholesale rejection of passive investing. Rather, it reflects a recalibration. Passive strategies remain highly effective in efficient markets and continue to offer low-cost at scale exposure to broad asset classes. Rather, their limitations become evident in complex, rapidly evolving environments where differentiation, flexibility and judgment are required. Active management thrives not on uniformity but in fragmentation, not on stability but in disruption and disruption is now the new normal in the global economy.
Looking ahead, the rise of new geopolitical blocs, onshoring of manufacturing, technological bifurcation, demographic shifts and climate transition will ensure that global markets remain anything but passive. These are forces that will create winners and losers—not just among companies, but also among countries, industries and capital allocators. In such a world, the ability to actively allocate capital based on deep understanding, foresight and real conviction may once again be the hallmark of superior investment performance.
In conclusion, while passive investing has earned its place as a cornerstone of modern portfolio construction, it is no longer the only game in town. The return of active management is not a fad but a response to structural change. As volatility becomes the norm rather than the exception, investors who embrace thoughtful, active strategies may find themselves better equipped to navigate risk, capture opportunity and achieve differentiated outcomes in a reshaped financial world.
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