Passives. The rulebook is becoming the fund manager
Peter McGahan
Monday 27th July, 2026.
THERE is a danger with anything sold as simple. A tracker fund should give you the market return at a low cost. That was the deal.
Passive funds have done investors a great service by cutting costs and helping ordinary savers access markets through ISAs and pensions. But small and cheap are not the same as safe. Mosquitoes are small too.
Terry Smith’s fund fell 2.9 per cent in the first half of the year while the MSCI World Index rose 11.2 per cent. He argues that markets are being driven less by profits, cashflow and valuation, and more by flows, momentum and index mechanics making you buy.
That sounds technical, but it is not. The index/passive is often not asking: “Is this company good value?” It may be an exchange-traded fund buying because the index tells it to, or an algorithm buying because the price is rising.
Remember my columns over the last few months covering Peter Lynch where he says you need to know what you invest into and ensure it has the fundamentals?
The original sales pitch for trackers was average market performance cheaply. Smith points out that Vanguard’s UK All Share tracker has delivered 66 per cent over five years against 32 per cent for the average UK equity fund. That is not just a fee saving. It is a different animal wearing the same collar.
The reason sits in the machinery. Most mainstream trackers are market-cap weighted. The bigger a company becomes, the more of it the index owns. The more money flows into the index, the more that same company is bought - like giving more pudding to the child who has already eaten most of the pudding.
Wonderful on the way up. Cup of tea. Feet up. But your ISA or pension can quietly become quite concentrated in yesterday’s favourite shares, sectors and themes without you choosing that risk. That can become a large, concentrated bubble. A market downturn sells at the same pace. Know what you own and why.
SpaceX is a useful example. This is not about whether it is a good company. The issue is who is forced to buy, and when. Nasdaq changed its rules so that a very large new listing could enter the Nasdaq-100 quickly. SpaceX listed in June and was added less than a month later! Really? JP Morgan estimated that inclusion
could create about $4.3billion of passive inflows. That is buying without asking if the valuation makes sense. A one-month-old company!
So, a UK saver in a Nasdaq-100 tracker, or a global or multi-asset fund with that exposure buried inside it, may now own SpaceX not because an adviser weighed the governance, profits, debts and valuation, but because the index rulebook changed.
That is the quiet dangerous shift. The rulebook is becoming the fund manager.
Index inclusion is always automatic. Some providers moved quickly. S&P did not create the same fast route for the S&P 500, leaving SpaceX outside that index for now. These are decisions made by committees, commercial organisations and rule-writers. SpaceX peaked at $201 dollars after four days of trading and is now at $115. Down 42 per cent in a month. Nice if you were forced into it.
There is also concentration. The top five stocks in the UK market account for nearly 35 per cent of its value. Global indices have their own version, with US mega-cap technology and artificial intelligence shares carrying a large part of the market’s return. You can own several cheap funds and still find they hold the same fashionable shares in different wrapping paper. That is not diversification. That is buying a cheese sandwich from three different shops and calling it a picnic.
Then there is governance. An active manager can say: “No, thank you.” A passive manager usually cannot, without breaking from the index. Voting and engagement matter, but passive funds are built on low costs and huge scale.
This is not an argument against passive investing. That would be daft. Passives are often excellent building blocks. But they are tools, not religions.
Investors still need to know what index they own, how concentrated it is, what gets added, what gets removed and whether the fund lends stock. That’s important. None of those things automatically make a fund bad. Hidden risk is the problem.
Use trackers where they fit the plan. Avoid paying active fees to managers who are really closet-tracking in a nice tie.
But do not confuse cheap with safe, or rules-based with risk-free. Passive funds do not remove judgement. They move it from the fund manager to the index rulebook.
And before you hand your pension to a rulebook, it is worth reading the rules.
I will be creating a guide to investing, so, if you would like a complimentary copy, please email info@wwfp.net.
Peter McGahan is the Chief Executive Officer of Independent Financial Adviser firm, Worldwide Financial Planning. Worldwide Financial Planning is authorised and regulated by the Financial Conduct Authority.
