Tough Times for Stockpickers: Passive Index Funds Continue To Dominate

Passive or active? Traders work on the floor of the New York Stock Exchange during morning trading in New York City. (Michael M. Santiago/Getty Images)

Key Points

• A Jefferies report shows passive investing strategies are gaining market share as active stock-picking strategies continue to underperform.
• Assets in passive U.S. equity exchange-traded and mutual funds hit $16.3 trillion as of July 31, representing 63% of all domestic fund assets.
• Jefferies strategists noted that less than 40% of active managers are beating their benchmark amid high market concentration in tech and AI.

Bad news for active fund managers.

A recent report by Jefferies shows that passive investing strategies are attracting an even greater share of investor inflows as stock-picking strategies underperform. And Jefferies warns that this likely to continue for the foreseeable future.

Jefferies equity strategist Steven DeSanctis and his team wrote in a report Thursday that assets in passive U.S. equity exchange-traded funds and mutual funds hit $16.3 trillion as of July 31. That’s 63% of all domestic fund assets, up from 60% at the same time a year ago according to data from Jefferies and fund flow tracker EPFR Global.

“The sad reality is that active is struggling again this year and so we will most likely see this trend to continue in 2027,” the Jefferies analysts wrote.

The S&P 500 is up 11.6% this year and is only about 2% below its all-time closing high. The blue chips have been led by Triple-digit percentage gains in stocks tied to the artificial-intelligence trade such as Sandisk, Dell, Micron, Intel, Seagate and Marvell .

It’s hard for active managers to top passive funds that track major indexes given the infatuation with AI and the heavy exposure to Big Tech in the S&P 500. “The market is still concentrated,” the Jefferies strategists wrote, noting that less than 40% of active managers are beating their benchmark.

The market’s lingering obsession with tech stocks seems to be the main reason why DeSanctis and his fellow strategists decided to title their report “The Song Remains The Same,” a nod to the Led Zeppelin song. But that tune could soon change—at least for some types of active funds.

However, the surge in passive ownership could be a warning sign, the Jefferies strategists said. “Over time, we have found that big increases in passive ownership serves as a potential top to performance and a needed pause takes place,” they wrote.

What’s more, some active fund managers say there are better opportunities outside of the U.S. stock market.

Noah Monsen, a co-manager of the Thrivent International large-cap ETF and Thrivent International Small Cap ETF , said in an interview with Barron’s that other developed markets, most notably Europe, don’t have the same level of AI exposure as the U.S. and other markets like Taiwan and South Korea do. And according to a recent report from Morningstar, active fund managers have a better track record of beating their benchmarks than U.S. funds do—although most still lag broader market indexes.

“We see much less concentration to AI in both funds,” Monsen said. Although European chip company ASML is the top holding in the large-cap fund, most of the portfolio’s biggest weightings are in healthcare, financials and energy stocks, including Novartis, Allianz and Shell. The small cap fund has more than 40% of it assets in industrials and financials.

Nick Elward, head of institutional product and ETFs for Natixis Investment Managers, also said demand for overseas companies has picked up.

“We’ve seen more investors looking to international markets to diversify. Yes, there is some concentration risk with tech and AI in South Korea and Taiwan but there are good opportunities elsewhere,” he told Barron’s.

To that end, Elward noted increased interest in two Oakmark funds, the Oakmark Global large-cap ETF and Oakmark International large-cap ETF . Natixis owns Harris Associates, the advisor to the Oakmark family of ETFs and mutual funds.

So even though passive funds remain the top choice for many investors looking to cash in on the AI trade in the U.S., active managers may still have a leg up on the indexes when it comes to international stocks.

Write to Paul R. La Monica at paul.lamonica@barrons.com

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