Guy Wagner from BLI on the hidden risks of passive investing
11 NOV, 2025
By Joanna Piwko from RankiaPro Europe
Passive investing has become the default choice for millions of savers. Index funds and ETFs promise low fees, broad diversification and “market” returns with almost no effort. For a long-term investor, that sounds perfectly rational.
Guy Wagner, Chief Investment Officer at BLI – Banque de Luxembourg Investments warns that what makes sense for each individual can become dangerous when everyone does it at once. A strategy designed to quietly track the market has grown so large that it now helps shape the market.
When “passive” stops being neutral
Index funds don’t ask whether a company is cheap or expensive, well managed or badly run. They simply buy whatever is in the index, in proportion to its size. As Wagner stresses, they follow rules, not reasoning.
The larger passive investing becomes, the fewer active investors are left doing the hard work of analysing businesses and correcting mispricings. Prices then reflect the weight of money flowing into indices as much as they reflect corporate fundamentals. Markets still move, but their movements tell us less about the real state of companies and the economy.
The feedback loop of market-cap indices
Most big stock indices are weighted by market capitalization: the larger a company’s market value, the more space it takes up in the index. Wagner likes to highlight the circular logic this creates.
When a company’s share price rises, its market cap goes up. That increases its index weight. Index funds must then buy more of it to stay in line with the benchmark. Those extra purchases can push the price still higher, further boosting its weight.
Instead of acting as a brake on excess, passive flows can become an accelerator. Expensive stocks are rewarded with even more automatic demand, and the normal tendency for valuations to drift back towards their long-term averages is weakened. Over time, this can inflate bubbles in fashionable sectors and starve less glamorous but solid businesses of capital.
Concentration, correlation and the illusion of diversification
One of the great selling points of passive investing is diversification. Buy the index, we are told, and you own “the whole market”. Guy Wagner’s worry is that this diversification is increasingly an illusion.
In many indices, a handful of giant companies now dominate the total weight. A portfolio that looks broad on paper may in reality depend heavily on the fortunes of a small group of mega-caps, often clustered in the same sector or style. If those firms stumble, the entire index feels the impact.
At the same time, index funds and ETFs tend to buy and sell large baskets of stocks together. That pushes different companies to move more in sync, even when their underlying businesses have little in common. Correlations rise, and in a downturn many holdings fall at once. Exactly when investors most need diversification, they may find that everything seems to behave the same way.
Liquidity: daily promise, fragile reality
Most passive funds offer daily liquidity and tight trading spreads. To the end investor, it can look as though they can always get in or out at a fair price. Wagner cautions that this perceived liquidity rests on shaky foundations.
A growing share of many companies’ shares now sits inside long-term passive vehicles. In normal times, turnover is low and everything feels smooth. But if investors were to rush for the exits, passive funds would have to sell large volumes of the same stocks at the same time. The underlying market may not be deep enough to absorb those sales without sharp price swings.
Where funds use derivatives to replicate an index instead of holding all the physical shares, another layer of complexity is added. Exposure becomes more synthetic, leverage can creep in and the link between the product and the real economy weakens further.
Power without analysis: the governance problem
Because they own big stakes in thousands of companies, the largest passive managers – notably BlackRock, Vanguard and State Street – now exercise enormous voting power. They influence decisions on executive pay, mergers, environmental policies and more.
Wagner points out the obvious tension: these firms are supposed to be “passive” owners, yet they wield highly active influence. And no one team can deeply understand every company in a portfolio built to mirror an entire index. Responsibility for corporate governance has become concentrated in a few hands that, by design, do not discriminate much between one business and another.
That may be convenient for index providers, but it is not obviously healthy for capitalism.
Spillovers to the real economy
The rise of passive investing doesn’t stop at the stock market. It affects how companies raise money, how competition works and who benefits from growth.
If public markets are dominated by price-insensitive index funds, going public becomes less attractive for many firms. Private equity and venture capital can look more appealing, keeping dynamic businesses out of reach for ordinary savers. Incumbent index members enjoy a structural advantage: they automatically receive capital as long as they remain in the benchmark. Challengers, meanwhile, struggle to be seen.
Over time, Wagner argues, this can reinforce market concentration and contribute to widening wealth inequality. The gains flow disproportionately to those who already own the large, index-heavy companies.
Why we still need active investors
None of this means that passive investing is “bad” or that individuals should never use index funds. Guy Wagner is clear: low-cost, diversified products have a place in many portfolios.
His point is that markets also need a critical mass of truly active investors who research companies in depth, challenge market narratives, and are willing to differ from the index when prices detach from reality.
Active managers, at their best, keep markets honest. Without them, indices become self-referential loops, and capital is allocated more by rule than by judgement.
One way forward, Wagner suggests, is to rethink how we build indices themselves. Approaches that give each company an equal weight, or that weight by fundamentals such as revenues or earnings rather than share price, can reduce extreme concentration and inject a bit of contrarian discipline into otherwise systematic strategies.
Conclusion: individually rational, systemically risky
For a single saver choosing funds in a retirement plan, a global equity index fund at low cost is still a perfectly sensible choice. Guy Wagner’s warning is about what happens when that individually rational decision is scaled up to dominate the entire system.
Passive investing has brought undeniable benefits. But as it continues to grow, it also brings hidden risks: weaker price discovery, inflated valuations, greater concentration, fragile liquidity and an unhealthy concentration of governance power.
The challenge now is not to abandon passive strategies, but to rebalance the ecosystem: keep the efficiency and simplicity they offer, while preserving enough active, thoughtful capital to ensure that markets remain anchored in economic reality rather than in the mechanics of their own indices.
