Are Active Managers Bringing a Knife to a Gunfight?

How passive investing has permanently changed market structure — and why sophisticated tools are now the price of survival

Stock volatility is at unprecedented levels. Whether it is Cochlear’s April trading update, the 2026 Hormuz crisis, Liberation Day in 2025, or a company reporting season, the swings are sharper and less anchored to fundamentals than at any previous point in market history. The market structure has permanently changed in how equity prices are set, and the consequences are being felt unevenly across the active management industry. The wide dispersion of returns away from fair value has produced an equally wide dispersion of outcomes for active managers.

Whether a manager runs a value, growth, or quality investment style, the propensity for extreme outperformance and underperformance has risen sharply. The rotations between investment styles have become faster and more extreme than at any previous point in market history. Growth managers were devastated in 2022, only to recover strongly in 2023. Value managers underperformed through 2024 before conditions finally turned in their favour in 2025. Now growth is under pressure again and this time quality managers have not been spared.

The driver of this structural change is the relentless migration of capital from discretionary active management into passive index funds and ETFs. As active participants retreat, the corrective mechanism — the wisdom of crowds — that keeps prices anchored to fair value is weakened. When that diversity erodes, prices become self-reinforcing rather than self-correcting. In a passive-dominated world, it becomes easier to inflate a boom, but when the correction comes it is faster and more violent.

The cycle is self-reinforcing: more passive flows produce more valuation dispersion, which produces more extreme active manager performance, which drives more flows into passive as disappointed investors give up on active management entirely. Active managers who do not understand how the market structure has changed are paying dearly for it.

The Apex Predators

As discretionary active management retreats, a more sophisticated class of price-setter has taken its place. Multi-strategy hedge funds (pod shops) and quant funds have become the fastest-growing segment of the active industry.

According to Goldman Sachs, pod shops' assets under management reached a record US$428 billion in 2025, up from just US$91 billion in 2010: a near five-fold increase in fifteen years. But their assets under management figure alone dramatically understates their true market footprint as they use considerable leverage. Data from the US Office of Financial Research shows that the gross leverage of pod shops is approximately 12x today, implying gross market exposure in the vicinity of US$5 trillion. Combined with their active trading, pod shops now account for over 30% of US equity trading volume.

Meanwhile, growing alongside pod shops are quant funds, systematic strategies running mathematical models across thousands of securities simultaneously. In 2025, quant funds captured more than 70% of all net inflows into hedge funds as investors sought strategies uncorrelated with volatile broader markets. Together, pod shops and quant funds represent a structural takeover of price discovery by systematic players.

These are the apex predators who set prices now. They take signals from price momentum, earnings revisions and other factors — valuation is almost entirely irrelevant. When a fundamental catalyst triggers, pod shops react first, in size, and with leverage. Quant funds pile in at a speed and breadth no discretionary manager can match, amplifying the initial move through a market with limited valuation-sensitive counterweight. The danger is not their failure — it is their success, and what it does to prices when they all move together, leaving traditional managers to lose if they are caught on the wrong side.

The Evidence

As the active, valuation-sensitive base shrinks, a small shift in participation by apex predators generates a disproportionately large price move. This effect intensifies as passive grows further. The evidence of disproportionate moves has three market fingerprints:

1.      Outsized Reactions to Results

Reporting season is a key period when market expectations change as companies report their results and provide their outlook. In the past, share price reactions of greater than 10% on results day were rare for the top 100 stocks. Since 2020, moves of that magnitude are becoming more prevalent. For example, when Coles reported its FY25 results in August 2025 its share price surged 8.5% in a single session and 16% in three days, hitting an all-time high. Six months later, reporting its H1 FY26 results in February 2026, the same company’s share price crashed 7.3% on the day. Not what you would expect from a large company selling groceries.

2.      Outsized Performance to Earnings Revisions

A single earnings beat triggers an outsized price move. A sustained revision trend amplifies it further. For over two decades, Commonwealth Bank's (CBA) annual share price returns tracked its annual EPS revisions. Since 2020 that relationship has been amplified. CBA delivered 50% annual price returns in both 2021 and 2024 despite modest earnings per share (EPS) revisions. The same dynamic is visible in BHP. In 2017 and 2021, it took EPS revisions approaching 100% to deliver 50% annual returns. Now a modest 9% revision has delivered the same result. These are the two largest, most heavily researched, most widely held, most liquid stocks in the index. If it is happening to them, no stock is immune.

Source: Vertium, FactSet

And it is not isolated to Australia. It is a global phenomenon where index heavyweights and sector leaders are moved by the same mechanical forces. It applies just as much to cyclical giants like ExxonMobil as it does to consumer staples stalwarts like Costco.

Source: Vertium, FactSet

3.      Valuations can become extreme

With flows overpowering fundamentals, valuations can become extreme and old narratives can completely reverse. Telstra was once the quintessential market laggard — a hollowed-out telco stripped of its copper network by the Government. Today its PE ratio is trading at close to all-time highs as it has not experienced any earnings downgrades since 2020. CSL tells the opposite story. Once the undisputed market darling, CSL has seen a series of earnings downgrades over the last year, driving its PE ratio to an all-time low. It is no longer about cheap or expensive valuations — it is about flows, and who controls them.

Source: Vertium, FactSet

The wide disparity in valuations creates fantastic opportunities for active managers. However, the persistence of these extreme valuations can also trap managers — selling an expensive stock only to watch it get more expensive or buying a cheap stock only to watch it get cheaper. A fundamental lens reveals the valuation but not whether the flows are with you or against you.

Large-cap stocks are now moving like small-cap stocks, because a shrinking number of market participants are determining the clearing price. With fewer valuation-sensitive participants to absorb buying or selling pressure, even a small fundamental catalyst now triggers an outsized mechanical squeeze. Asset prices now move more for a given dollar of net buying or selling than at any previous point in market history.

Sophisticated Tools Are No Longer Optional

Ken Griffin, whose Citadel is among the most successful pod shops ever built, has observed that his best traders are correct only 54% of the time. Renaissance Technologies' Medallion Fund, the most successful quant fund in history, achieved average annual gross returns of 66% over three decades with a win rate barely above 50%. In both cases, the edge was not stock picking accuracy. These firms share the ability to cleanly separate alpha from beta, knowing precisely how much of any return is skill and how much is explained by market or other factors. That clarity allows them to manage risk with precision — ensuring the losses never overwhelm the gains. The research, the technology, the systematic process, and the ability to control risk in real time results in a genuine competitive moat.

That moat is what traditional active managers must now build to survive. They typically focused on one thing: generating returns. Risk management was informal and portfolio construction was an afterthought. That was sufficient when valuation sensitive participants were the dominant force that kept prices closer to their fair value. It is not sufficient now.

Druckenmiller captured the problem precisely:

"People always forget that 50% of a stock's move is the overall market, 30% is the industry group, and then maybe 20% is the extra alpha from stock picking."

— Stan Druckenmiller

The instinct for many managers is to attempt to improve stock selection, whether through better qualitative research or by adding quantitative screens. But that only addresses the 20%. The issue is the 80% that most active managers are not managing (the market, the sector, and the factor dynamics), and that is precisely what a sophisticated toolkit addresses. What is required is a thorough understanding of every dimension of how a security moves: managing position sizing against its underlying risk and monitoring how securities behave in relation to each other and to common factors across different market regimes. These volatility and correlation dimensions are not refinements layered on top of returns — they are the foundation that reveals risks that fundamental analysis alone cannot see. A manager operating purely from fundamental conviction, with little systematic framework for understanding how positions interact, is perpetually at risk of being blindsided by the next rotation before they have recovered from the last.

None of this makes fundamental analysis obsolete. Both fundamental and systematic active managers continue to play a critical role in supporting price discovery and capturing inefficiencies that passive strategies cannot address. But capturing that opportunity requires acknowledging that today's market is dominated by sophisticated players who execute with machines. The manager who understands both the fundamental picture and the mechanical forces acting on it is operating with a genuine edge. The manager who understands only one is, quite literally, bringing a knife to a gunfight.

Conclusion

Passive investing was sold as a democratising force. But at the scale it has now reached, it has fundamentally changed market structure — handing the price-setting function to pod shops and quant funds. The result is a market that amplifies every move, sustains valuations well beyond fundamentals, and produces style rotations that blindside unprepared managers.

The active managers who survive are those who have matched their tools and their thinking to the market they are operating in — not the market of twenty years ago. In a market with apex predators at the top of the food chain, survival requires the same level of sophistication. Anything less, and the predators will eat them alive.