As we typically do each quarter, today we revisit the debate between active and passive management by looking at how passive indices have fared across several different markets.
As we typically do each quarter, today we revisit the debate between active and passive management by looking at how passive indices have fared across several different markets – US large cap equity, US small cap equity, international developed equity, emerging market equity, and US fixed income – over both the short- and long-term.
Thus far 2025 has provided us with a good opportunity to evaluate active vs passive management as we’ve experienced a major drawdown and subsequent recovery. One of the arguments in favor of active management is that active managers will outperform in down markets. The tariffs that were a major contributor to the downturn had been anticipated for some time, potentially allowing managers to position their portfolios accordingly.
The key determinant of which style, active or passive, is superior is market efficiency. Market efficiency describes the degree to which asset prices quickly and rationally adjust to reflect new information. In highly efficient markets, new information is quickly incorporated into prices, and therefore it is not possible to consistently achieve above-average risk-adjusted returns in these markets. Therefore, due to their lower cost, investors are better off utilizing passive strategies in highly efficient markets. In less efficient markets, on the other hand, the opportunity exists for skilled active managers to outperform passive strategies, thereby adding value for clients.
The active vs. passive debate often focuses on large-cap U.S. equities, which is a natural starting point for the discussion – the large-cap U.S. equity market is composed of the most well-known companies in the world and represents a large portion of many retirement portfolios. However, if we stop there, we ignore what should be an obvious and fundamental element of the discussion – the various markets around the globe are unlikely to all be equally efficient. The very fact that U.S. large-cap companies are the most visible and researched firms in the world suggests that the U.S. large-cap equity market is likely to be more efficient than its less well-known counterparts! It is because of the variation in efficiency that the merits of active versus passive management should be evaluated on a market-by-market basis.
On the surface, the debate between active and passive may seem academic. However, it has practical implications for advisors. Most importantly, you want to do what is in the best interest of your client. If your client is best served by using low-cost passive funds because active management truly doesn’t add value, then so be it. However, utilizing only passive funds eliminates one of your value propositions as an advisor – evaluating and selecting funds – and removes any possibility of outperformance, so, from a business perspective, it is probably preferable to keep at least some active management in the mix.
The tables below show the quarterly, year-to-date, and rolling five-year return rankings of several well-known indices (representing passive management). If the index ranks in the top two quartiles, then it outperformed most managers within the peer group during that period. Conversely, if the index ranks below the 50th percentile, then most active managers in that universe outperformed the benchmark. Looking at the rankings over time, we can get a feel for which markets are the most efficient, and thus are likely to favor passive management, and which are the least efficient, offering the greatest opportunity for active managers.
The earliest five-year period in our long-term rankings began in June 2016 and the most recent period ended September 30, 2025. During that time, we have experienced several different market environments and market-shaping events from the calm of 2017 to the volatility of 2020 and the tariff-driven drawdown this year. So, we have a good cross-section of market states upon which to base our conclusions.
Large Cap US Equities
As has generally been the case over the long-term, the S&P 500 (SPX) was a challenging benchmark for active managers in 3Q25 as the index finished around the 75th percentile. There is some evidence that active managers successfully positioned their portfolios ahead of the sell-off in US stocks as the S&P finished the first quarter in the third quartile of our rankings. If that was the case, however, active managers were less successful in anticipating and positioning for the recovery as most underperformed the benchmark in Q2 & Q3. Through three quarters, the S&P 500 sits in the second quartile, suggesting that while active managers enjoyed some success early in the year, they have struggled against the benchmark down the stretch, as has been the case over the long term.
Small Cap US Equities
Like their US large cap counterparts, most active small cap managers underperformed the benchmark in the second quarter. The Russell 2000 finished the third quarter squarely in the first quartile and now sits right around the 75th percentile through the first three quarters of the year. While the outperformance by the S&P is in keeping with the longer-term trend, the Russell 2000’s outperformance is more surprising as small cap managers have generally outperformed the index in most of the rolling five-year periods.
Developed International Equities
The MSCI EAFE Index has hovered right around the 50th percentile throughout most of 2025. As the rolling five-year rankings show, this has also been the case over the longer-term with no clear advantage for active or passive management
Emerging Market Equities
The MSCI Emerging Markets Index finished Q3 in the second quartile of rankings and now ranks above the 50th percentile through the first three quarters of the year. The outperformance of the benchmark runs counter to the longer-term trend as the index has finished below the 50th percentile in the last 13 rolling five-year periods, suggesting an advantage for active management.
Fixed Income
The US Agg finished the third quarter near the 25th percentile and sits in the bottom quartile the rankings year-to-date. The year-to-date results are in-line with the longer-term trend, which has clearly favored active over passive management in fixed income as the Agg has finished in the bottom quartile of the rankings in every rolling five-year period in our lookback window.
