Stu Morrow, CFA | Investment Counsellor, Private Wealth

Most investors holding a market-cap-weighted index in 2026 have, without necessarily choosing to, made a concentrated bet on a single theme. 

That isn’t a reflection of a change in the index's rules, but rather the scale a small number of companies have reached. Understanding what that means for your portfolio is where the active versus passive debate actually begins.

The evidence, examined carefully, does not support a categorical answer in favour of either approach. The more useful question is not which approach is better, but which is better suited to a given market, in the hands of a given manager.

What "Passive" Actually Means

Passive investing means buying a fund (e.g. a mutual fund, pooled fund, or exchange-traded fund) designed to replicate the performance of a market index: the S&P 500 (U.S.), the TSX (Canada), or the MSCI World. You pay a small fee to the fund provider, plus transaction costs, to track the index as faithfully as possible, regardless of underlying fundamentals and valuation. There is no active assessment of whether any individual holding is fairly priced.

In practice, it raises a question worth asking: what exactly is the index, and is it something you would actually want to own if given the choice?

The question is particularly relevant in 2026. Some of the largest private technology companies in history are approaching public listings this year, and the timing of when passive investors gain exposure cuts both ways. Some index providers have moved to accelerate inclusion timelines for very large IPOs; others, including S&P Dow Jones Indices, have confirmed they will maintain existing requirements. That means passive S&P 500 investors could wait well over a year for automatic exposure to these companies. 

Early inclusion carries its own risk. Adding a company to a benchmark before it has traded through a full market cycle can mean passive funds may potentially buy at peak valuations, with no ability to judge the price. Active managers face no such constraint. They can participate on their own timeline, at sizes they judge appropriate, or not at all.

The Concentration Problem

Most major equity indexes are capitalization-weighted: the larger a company's market value, the larger its share of the index, and the more of every passive dollar flows to it. As a price rises, so does its weight, which means the index automatically holds more of whatever has already climbed the most, regardless of whether the price still reflects underlying value. Conversely, when flows turn negative, passive funds sell indiscriminately at whatever the current price happens to be, with no regard for the quality of the business being sold.

The S&P 500 today is not a broadly diversified basket of 500 companies. It is a heavily weighted bet on a small number of mega-cap businesses, and increasingly on a single theme: artificial intelligence. What makes the current concentration particularly significant is that the AI exposure runs well beyond the largest names at the top of the index. When accounting for companies with meaningful AI infrastructure, capital expenditure, or revenue exposure, roughly one-third of the S&P 500 by weight carries material AI sensitivity (BlackRock, April 2026). Unlike past periods when the top holdings spanned unrelated industries, today's leaders are closely linked by a shared bet on AI adoption and monetization. That's not inherently wrong. But it's worth understanding.

This concentration problem has historical precedent. At the height of the dot-com bubble in 2000, Nortel Networks represented approximately 35% of Canada's TSX 300 index. A passive Canadian investor had no mechanism to reduce that exposure before Nortel collapsed by more than 95%. Similar episodes played out across Europe: Nokia at roughly 60% of Finland's index, Ericsson at 32% of Sweden's, Telefónica at nearly 28% of Spain's IBEX 35. In each case, the benchmark had become a concentrated sectoral bet. Passive investors had no way to step aside unless they sold the whole fund at an opportune moment.

An active manager with a valuation discipline may operate differently. Rather than owning every company in proportion to its market weight, a skilled active manager can assess whether a stock's price reflects its underlying business prospects, reducing exposure where valuations have detached from fundamentals, and adding to companies that have been overlooked or unfairly sold off. That asymmetry, where the ability to distinguish a temporarily cheap business from a deteriorating one, is among the most practical benefits active management can offer when it is applied with conviction and patience.

The Case for Passive Investing

Passive investing's strongest argument is as much behavioural as it is financial.
Costs matter. An index fund charging a few basis points per year gives you a compounding advantage over an active fund charging multiples of that. An active manager has to overcome that gap every year before adding a dollar of net value. Over 20 or 30 years, that fee difference compounds into a significant drag on wealth.

Cost, though, is only half the argument. Research in behavioural finance has consistently found that investors make predictable errors: chasing recent performance, selling during downturns, treating short-term noise as a meaningful signal. These behaviours can destroy value in any portfolio, active or passive.

What actually matters is staying invested with discipline through a full market cycle. Passive funds can help with that: owning the index removes the temptation to trade individual positions, and lower turnover typically means fewer taxable events along the way. The same logic applies to a patient, high-conviction active manager. One whose approach you understand well enough to hold through a difficult quarter without abandoning it. The structural advantage is not passive over active. It is having a strategy you can maintain.

The Case for Active Investing

The conventional critique of active management is built almost entirely on one data set: U.S. large-cap equity funds, measured against the S&P 500, largely over the post-2008 era of historically low volatility and narrow, technology-driven market leadership. The SPIVA U.S. Scorecard, published semi-annually by S&P Dow Jones Indices, is the most comprehensive source of this evidence.

This evidence only captures part of the story.

Research from Hartford Funds, examining active and passive performance across full U.S. market cycles, finds that the relative advantage of each approach has been cyclical rather than permanent. When return dispersion is high, meaning the gap between the best and worst performing stocks within an index is wide, active managers have tended to outperform, because there is more value to add through selection. When dispersion is narrow and a handful of mega-cap names drive most of the index's return, passive tends to have the upper hand. The implication is not to abandon one approach for the other; it is that you cannot reliably know in advance which environment you are entering. A considered combination of both tends to be more durable than a binary commitment to either.

Fixed Income

In fixed income, the case for active is arguably compelling. A 2024 Morgan Stanley Investment Management study found that active bond managers outperformed passive alternatives in 87% of rolling three-year periods across nine fixed income sectors. A 2024 study by Cremers, Choi, and Riley makes a point worth understanding: unlike stocks, many bonds in a typical fixed income index are difficult to trade in size, so even a fund marketed as 'passive' has to make real investment decisions just to track it accurately. True passive bond investing is harder than it appears. The most actively managed bond funds in the study outperformed by 0.74% per year on average, while also losing less in difficult market conditions.

Two structural features of bond markets explain much of this edge. First, bond indexes are weighted by how much debt a borrower has issued, which means the most indebted companies automatically receive the largest allocation. An active manager can assess whether that debt load is sustainable; a passive fund has no such discretion. Second, most bonds do not trade on an exchange. They change hands privately between dealers at prices that are not always publicly visible. An active manager may be able to source bonds at better prices than a passive fund that must buy whatever the index requires, at whatever price is available.

Emerging Markets

In emerging markets, the case for active is compelling but nuanced. Research by Busse, Goyal, and Wahal (2010) found that institutional-quality active managers outperformed passive strategies by more than 180 basis points per year on average, an edge driven by market inefficiency, thinner analyst coverage, and information gaps that do not exist in large developed markets. 

More recent analysis (Hang Seng Investment, 2024) confirms the pattern holds in specific markets: active funds beat their benchmark in India in 6 of 10 years and in China A-shares in 7 of 10. The results are less consistent across the broader retail universe of emerging market equity funds, where manager quality varies considerably. The key takeaway is that emerging markets offer a real opportunity for active management, but both the market and the manager matter.

A Note on "Fake" Active Management

One further distinction is worth noting. Cremers and Petajisto's influential “Active Share” framework, which measures how much a fund's holdings differ from its benchmark, found that active managers with high active share and patient holding periods have meaningfully outperformed over time. The underperformers were mostly “closet indexers”: funds charging active fees while essentially mimicking an index. Much of the empirical case against active management is, more precisely, a case against fake active management.

Applying This to Your Portfolio

The right balance of active and passive depends on several interconnected factors.

Your Time Horizon

Passive strategies tend to reward patience, since they capture broad market returns across full cycles before any attempt to add value through selection. Investors drawing down a portfolio in retirement, or those with shorter time horizons, may have the most to lose from index-level concentration risk precisely when stability matters most.

Your Risk Tolerance and the Value of Downside Protection

When done well, active management offers something passive can’t: the ability to reduce exposure to overvalued or deteriorating holdings before the market corrects. . For investors who need their portfolio to hold up through periods of stress, whether for spending needs, estate planning, or financial constraints, the value of that flexibility matters. Skilled active managers in the right markets have historically provided a meaningful cushion in downturns.

Staying Invested

Both approaches fail investors who abandon them at the wrong moment. The behavioural advantage of a passive fund holds only if you remain invested through corrections that can, in a concentrated index, be deeper than those an active approach would experience. The potential protective value of active management in downturns depends entirely on having selected the right manager in the right market, for the right reasons.

The Considered Answer: Usually Both

Research published in the Journal of Financial Planning (Pittman, Russell Investments, 2017) put numbers to what many experienced investors have long concluded: the question is not which approach to choose, but how to allocate between them in a way that reflects each investor's willingness to accept returns that differ from the index. The model is instructive at its extremes. An investor with no aversion to active risk should be fully active. An investor who cannot tolerate any deviation from index performance should be largely passive. 

The choice between active and passive is ultimately a supporting decision, not the central one. What matters more is understanding what the portfolio needs to do: when the capital will be needed, what it needs to sustain, and what it needs to become. Those answers, drawn from a complete picture of a client's financial life, are what should drive the construction. Finding that balance is the work and it starts with a clear understanding of what the portfolio is meant to achieve.