Terry Smith warns passive funds could spark a market meltdown
Star fund manager Terry Smith has warned that the growing dominance of passive funds could trigger a 'major investment disaster'. His comments come as his own Fundsmith Equity fund struggles to keep pace with broader market gains, particularly those driven by a handful of tech giants in the stock market today.
Fundsmith Equity, launched in November 2010, has historically delivered strong returns, averaging 13.5% annually since inception. However, in 2025, the fund posted just a 0.8% return, lagging far behind the MSCI World index’s 12.8% gain.
Smith attributes the fund’s recent underperformance to three key factors. One major issue is the outsized influence of a small group of tech stocks—dubbed the 'Magnificent Seven'—which have dominated the S&P 500. Index investors, he argues, have little control over their exposure to these firms, as passive funds simply track the stock market. Fundsmith Equity itself holds only three of these seven tech giants: Alphabet, Meta, and Microsoft. Smith believes the rise of these large stocks is becoming a self-fulfilling prophecy, fuelled by the sheer scale of passive investment flows. He criticises the shift toward passive funds, warning that 'momentum' investing—where money chases already-rising stocks—risks distorting stock market valuations. His concerns extend beyond his own fund’s performance. The concentration of capital in a narrow pool of stocks, he argues, could eventually lead to instability if investor sentiment shifts abruptly.
Smith’s warnings highlight the growing tension between active and passive investment strategies. While Fundsmith Equity has thrived over the long term, its recent struggles reflect the challenges faced by active managers in a market increasingly shaped by a few dominant players. The fund’s limited exposure to the 'Magnificent Seven' has weighed on returns, underscoring the risks of diverging from the index-driven trend in the stock market today.
