One of the main reasons that active and passive performance is cyclical is because the performance of large and small companies, in terms of market capitalisation, is cyclical. can often outperform in those times. This happened in the 2021-22 period, for example, when the global growth was rebounding from the pandemic but interest rates were still very low( which helps smaller companies more as they borrow more from banks). Active managers outperformed passives in that period.
There has been a structural flow into passives.
However, the cycles of active outperforming passive are getting shorter. In fact, rather than always going back and forth, it is increasingly becoming the norm for passive investing to outperform active – at least when taking into account active managers’ higher fees. There are many reasons for this.
Economically and financially, the world is in a sustained period of large cap dominance. This is exemplified by the Magnificent Seven – which recently made up around a quarter of the entire MSCI World Index. People used to think that small caps had better growth over the long-term, but those companies have been able to consistently grow their massive profits by taking advantage of their size and market share. Many are at the forefront of the AI investment boom,
for example, and that’ s where most investors expect longterm profit growth to come from.
This trend has been bolstered by investors’ growing preference for passive investing and their appetite for the biggest stocks. Retail investors – whose influence on markets is bigger than ever thanks to easy use investment apps – love buying Tesla. There’ s also so much algorithmic, high-frequency trading in markets these days, which increases momentum toward certain stocks. Momentum has become a much bigger influence on markets than it used to be, and momentum tends to swing towards the big names.
To a certain extent, these factors become self-reinforcing. Investors’ appetite for large cap stocks makes it much easier for them to access capital, which gives them more opportunities to grow profits. Those profits then make their stocks more attractive, driving even more investment their way.
April 2025 | 47