Passive investing has delivered strong results for a generation of investors – but Toby Watson argues that the conditions that made it so effective are changing, and the case for active management has rarely been more compelling.
The rise of passive investing is one of the defining stories of modern asset management. Low-cost index funds have outperformed the majority of active managers over extended periods, and the logic of capturing market returns at minimal cost has proven difficult to argue with. Yet, passive investing has genuine limits that become more significant as market conditions shift and major indices concentrate in ways that create real risks. Toby Watson, whose career has been built on active, analytically rigorous investment management, brings a clear-eyed perspective on where passive investing falls short and where active management genuinely earns its place.
The debate between passive and active investing is often framed as a binary choice, but the reality is more nuanced. Passive investing works best in markets that are highly liquid, broadly diversified and efficiently priced – conditions that describe some markets some of the time, but not all markets all the time. As concentration in major equity indices has increased and as the opportunity set in private markets has expanded, the limitations of a purely passive approach have become increasingly apparent. Toby Watson has engaged with this debate throughout his career and sees the question not as passive versus active, but as identifying precisely where active management is most likely to add genuine value net of fees.
The Case for Passive – and Why It Has Been So Persuasive
The academic and empirical case for passive investing rests on a well-established foundation. Markets are broadly efficient over long periods, meaning that consistently outperforming the market requires either superior information, superior analytical capability or a degree of luck that is difficult to distinguish from skill in real time. The majority of actively managed funds underperform their benchmarks after fees over extended horizons – a finding replicated across markets and time periods with remarkable consistency.
This evidence is genuine and should not be dismissed. For investors with longtime horizons and limited appetite for complexity, a low-cost passive strategy in liquid public markets represents a sensible choice. What Toby Watson has consistently argued is that the case for passive has limits – and that understanding those limits is essential for investors who want to optimise their portfolios rather than simply defaulting to the most convenient option.
Where Does the Passive Argument Start to Break Down?
The passive argument is most persuasive in deep, liquid markets with many well-informed participants – large-cap equities in developed markets being the clearest example. Toby Watson, who developed his active investment framework across nearly two decades at Goldman Sachs working across global capital markets, has noted that the conditions for market efficiency are considerably weaker in less liquid segments – mid-cap equities, emerging markets and private assets – where information is less uniformly available and pricing is therefore less efficient. In these markets, active management has a genuine structural advantage that aggregate underperformance statistics for active funds do not capture.
How Toby Watson Identifies Where Active Management Adds Value
Toby Watson’s framework begins with a clear-eyed assessment of market efficiency in the relevant segment. The question is not whether active managers in aggregate outperform – they do not, by definition. The question is whether specific structural features of a market create persistent opportunities for skilled active managers to generate returns above passive exposure.
Several such features stand out. Information asymmetry creates genuine alpha opportunities that passive strategies cannot access. Liquidity constraints create pricing distortions that patient, well-capitalised active managers can exploit. And complexity premiums – the additional return available to investors willing to do the analytical work required to understand complex instruments – represent a category of return that index funds cannot capture. At Rampart Capital, where Toby Watson serves as partner, active management is applied selectively in markets where these structural features are present.
The Concentration Problem in Major Indices
One of the more pressing practical concerns about passive investing is the degree of concentration that has built up in major equity indices. The largest companies in the S&P 500 now account for a historically unusual proportion of total index weight – meaning that a passive investor has, without any active decision, taken on a significant and concentrated bet on a small number of large-cap technology businesses. Toby Watson has noted that this creates a genuine risk management issue, and that active management or deliberate portfolio construction is needed to address it effectively.
Markets Where Active Management Has a Structural Edge
Toby Watson’s experience at Goldman Sachs, working across global credit, structured products and principal investing, reinforced a clear view of which markets reward active analytical work most reliably:
- Credit markets – particularly high yield, structured credit and private lending – reward detailed fundamental analysis in ways that equity markets, with their broader analyst coverage, often do not. Default analysis, covenant assessment and recovery modelling are areas where genuine skill produces differentiated outcomes.
- Private markets broadly – where pricing is not continuous and information is not uniformly distributed – represent the clearest case for active management. Index exposure to private equity or private credit is not meaningfully possible, making active manager selection the only route to accessing these returns.
Beyond these categories, two further areas merit consideration:
- Emerging markets – where information quality and governance standards vary considerably – create persistent opportunities for active managers with genuine analytical capability.
- Periods of market dislocation – when prices move far from fundamental values due to forced selling or liquidity stress – represent the moments when active management has historically added the most value. Passive investors are price takers; active investors with liquidity can be price setters.
Toby Watson on the Complementary Role of Passive and Active
The most sophisticated portfolios use passive exposure where markets are efficient and costs matter most, and active management where structural advantages make the additional cost worthwhile. Toby Watson’s perspective, shaped by his years at Goldman Sachs and his current work at Rampart Capital, is that the choice between passive and active is ultimately a question of where analytical rigour is most likely to be rewarded. In the right markets, with the right managers, active management does not simply justify its cost – it earns returns that no passive strategy could replicate. Toby Watson sees this selective, evidence-based approach to active management as one of the defining characteristics of serious long-term wealth management.
