In 1993, State Street launched the SPDR S&P 500 ETF (ticker: SPY), the first exchange-traded fund in the United States, with $6.5 million in assets under management. Thirty-two years later, the global ETF industry manages over $12 trillion, and passive funds — ETFs and index mutual funds — now control more than 50% of US equity fund assets, surpassing active management for the first time in 2024. This is more than a shift in investor preference. It is a restructuring of how capital is allocated across the global economy, with consequences that are only beginning to be understood.
The Numbers Behind the Shift
According to Morningstar, US passive funds attracted approximately $1.4 trillion in net inflows in 2024, compared with roughly $400 billion in net outflows from actively managed funds — a net swing of $1.8 trillion. This is not a one-year anomaly. Passive funds have outperformed active funds on an after-fee basis in nearly every category and nearly every time period studied. The SPIVA Scorecard, published semi-annually by S&P Dow Jones Indices, consistently shows that 80-90% of actively managed US equity funds underperform their benchmark over 10-year periods. Over 20 years, the number approaches 95%. The math is brutal: after fees, the average active manager simply cannot beat the index.
The ETF structure has proven to be a superior delivery mechanism for passive investing. Unlike mutual funds, ETFs trade throughout the day on exchanges and their creation and redemption mechanism — authorised participants exchanging baskets of underlying securities for ETF shares and vice versa — provides tax efficiency that mutual funds cannot match. Vanguard’s patented dual-class share structure, which allows its ETFs to share the tax advantages of its mutual funds, has been a particular competitive advantage. Vanguard, BlackRock (iShares) and State Street (SPDR) collectively control approximately 75% of the US ETF market, a concentration that has raised concerns about voting power and corporate governance.
The Concentration Question
Critics of passive investing raise several concerns, some more valid than others. The most frequently cited is the voting power argument: BlackRock and Vanguard, through their index funds, are among the largest shareholders in virtually every publicly traded US company. In theory, this gives them enormous influence over corporate governance. In practice, the three largest index fund managers have implemented stewardship teams and proxy voting guidelines that are publicly available, and they generally vote with management on routine matters while engaging on governance and climate issues. John Coates, a former SEC official who wrote an influential paper on the topic, argued that the “Big Three” problem is more of a policy question than a market failure — it can be addressed through regulation rather than requiring a retreat from passive investing.
The more subtle concern is about price discovery. If passive funds represent a growing share of trading volume, the argument goes, fewer active investors are setting prices, which could lead to inefficient markets and increased fragility. The evidence on this point is mixed. Academic research suggests that even a relatively small proportion of active trading — perhaps 10-15% of volume — is sufficient to maintain efficient price discovery, and active trading volume, measured in absolute terms, has never been higher. Algorithmic and high-frequency trading, while controversial, ensure that markets remain liquid and that price discrepancies are arbitraged away within milliseconds.
Thematic and Active ETFs: The Next Frontier
The growth of passive investing has not killed innovation in the ETF market — it has redirected it. Thematic ETFs — funds focused on narrow investment themes like clean energy, cybersecurity, genomics or blockchain — have proliferated, with mixed results. The ARK Innovation ETF, which became a cultural phenomenon in 2020-2021, gained 153% in 2020 before losing 67% in 2022. Thematic ETFs have collectively underperformed broad market indexes, largely because they tend to launch after the theme is already popular and attract capital at peak valuations.
Actively managed ETFs, a relatively recent innovation made possible by the SEC’s 2019 “ETF Rule,” are the fastest-growing segment of the ETF market. Active ETFs accounted for approximately 25% of all ETF launches in 2024, including offerings from traditional active managers like Capital Group, T. Rowe Price and Dimensional Fund Advisors that had previously resisted the ETF structure. These funds blend the active stock selection of traditional mutual funds with the tax efficiency and intraday liquidity of ETFs, offering a compromise for investors who want the ETF wrapper but are not ready to fully embrace passive indexing.
The ETF revolution is not finished — it is entering its second act. The conversion of mutual funds into ETFs, the expansion of ETF offerings in fixed income and alternatives, and the gradual globalisation of the ETF market (which remains heavily US-centric) all point to continued growth. The $12 trillion ETF industry of today may well be a $25 trillion industry by the end of the decade. Whether that concentration of capital in passive vehicles is healthy for markets is a question that will be answered not by theory but by the next major market dislocation — which, as history teaches us, will arrive eventually.