We Thought We Beat the Market — Then the Market Swallowed Us Whole

The last ten minutes are everything.

Every day at 3:50 PM, something strange happens on the New York Stock Exchange.

The market, which has been dozing for six hours, suddenly wakes up. Orders flood in, trading volume spikes, and prices move.

In developed European markets, 35% of the entire day’s trading volume is processed in this single, final closing auction session. The US sees 15%.

Ten years ago, these numbers wouldn’t have existed.

This concentration wasn’t created by algorithms. It wasn’t created by hedge fund manipulation.

It was created by index funds.

More precisely: The philosophy of not trying to beat the market has fundamentally altered the market’s structure itself.

Passive investing emerged in 1976.

When John Bogle, through a company called Vanguard, launched the first index fund for individual investors, Wall Street’s reaction was cynical.

It was called “Bogle’s Folly.” The idea was, what kind of investment is it to simply replicate the market?

Fifty years have passed. In 2024, the assets managed by passive funds have, for the first time, surpassed those of active funds.

BlackRock, Vanguard, and State Street collectively own over 20% of the market capitalization of U.S. listed companies and exercise 25% of the voting rights at shareholder meetings.

These three firms are the single largest shareholder in 88% of S&P 500 companies.

The idea that was met with cynicism is now rewriting the very structure of capitalist governance.

This article isn’t about how great passive investing is. That’s already proven by the numbers.

This article is about what happens when that greatness becomes sufficiently large.

1. The Logic of the Revolution Was Correct

First, we need to understand why passive investing won. Because that reason is the root of the paradox we face today.

In 1965, Eugene Fama at the University of Chicago posed a peculiar question.

“If experts can beat the market, what does that mean?” His answer was almost provocative.

Market prices already reflect all available information. Therefore, any attempt to analyze that information to generate excess returns cannot, in principle, be sustained.

-> This is the Efficient Market Hypothesis.

Paul Samuelson applied this theory to practice.

After analyzing the performance of investment professionals in 1974, he stated bluntly:

‘Create a portfolio that simply replicates the S&P 500 index. It will perform better than most active funds.’

Bogle heard that advice. Two years later, Vanguard’s first index fund was launched.

Decades of data have accumulated since then. And the data has been brutal.

The SPIVA Scorecard, published annually by S&P Dow Jones Indices, consistently delivers the same conclusion.

Over a ten-year period, 84% of U.S. large-cap active funds fail to outperform the S&P 500 index.

International equities fare worse at 85%, and emerging markets at 87%. The numbers worsen with longer time horizons.

The reason can be explained by simple arithmetic.

The sum of all investors’ returns equals the market return.

Active funds charge fees on top of this. Therefore, the average active investor, after deducting fees, will always underperform the market average. This isn’t a statistical tendency; it’s a mathematical certainty.

William Sharpe proved this in a single paper in 1991.

The title of that paper was just three words: “The Arithmetic of Active Management.”

Costs determine everything.

Following Vanguard’s consecutive fee reductions in 2025 and 2026, major index funds now have an annual expense ratio of around 0.03% to 0.06%.

Active funds holding the same assets charge an average of 0.39%.

If you were to manage 100 million won for 20 years, this difference alone would result in tens of millions of won.

For individual investors, passive investing was a revolution.

No complex analysis, no exceptional intuition, no luck needed. Just buy the index. You perform better than 80% of professionals.

This is a fact. And it is precisely this fact that is now creating new problems.

2. Liquidity Concentrates in the Last Ten Minutes

Let’s rewind the story for a moment.

Imagine you are an index fund manager. Your mission is simple.

Replicate the S&P 500 index as precisely as possible. Your key metric is to keep the difference from the index, known as tracking error, close to zero.

So, when should you buy or sell stocks?

There’s only one answer: At the moment the index is calculated for its closing price, you must also trade at the closing price.

Buying at 10 AM creates a discrepancy between your purchase price and the day’s closing price.

This is tracking error. For passive funds, tracking error is failure.

Therefore, passive managers trade at the Market-on-Close (MOC) auction. Always.

[INFOGRAPHIC: “Where Does the Day’s Volume Go?” — A clean horizontal bar chart showing closing auction volume as percentage of total daily volume by region: Developed Europe 34.82%, Japan 23.80%, APAC ex-Japan 16.78%, United States 15.39%. Placed here to quantify the liquidity concentration phenomenon that has been building in the preceding paragraphs.]

The problem is, passive funds aren’t the only ones thinking this way.

As passive assets grow, trading volume increases just before the close. As trading volume increases, liquidity in the closing session improves. As liquidity improves, other investors also start trading at the close. This, in turn, further increases closing volume.

In economics, this is called “liquidity begets liquidity.” It sounds like a beautiful feedback loop. In reality, it’s not.

When you hear that 35% of daily trading volume in developed European markets is concentrated in the closing auction session, read it another way: the liquidity of the other six hours of the trading day is being drained.

Anyone who trades stocks has likely experienced the real consequences of this phenomenon. If you place an order in the morning, the bid-ask spread is wide. There’s no depth in the order book. Your single order moves the price. The conclusion that this is not just a daily anomaly but a structural trend is something that capital market researchers are now commonly reaching.

It’s a decline in the price discovery function.

In the past, the closing auction was a forum where the results of market participants’ individual analyses and judgments throughout the day were aggregated. Today’s closing auction is different. Passive funds and associated capital create supply and demand pressure that dictates, “The index must end here today.” Prices are formed not by changes in a company’s value, but purely by the physical force of index-tracking capital.

There are even more extreme moments. This happens on the day of quarterly index rebalancing. The entire passive fund universe simultaneously sells stocks being removed from the index and buys stocks being added. On this day, the prices of those stocks move by several percent for reasons unrelated to the company itself. The actual performance of passive funds forced to trade at these prices becomes lower than the index performance seen in backtests.

This is the first paradox of passive investing. Actions taken to reduce tracking error collectively create tracking error.

3. Those Who Move the Market and Those Who Make It

[IMAGE: An aerial view of a dense city grid at night, with one massive, brightly lit skyscraper dominating the landscape. Multiple small office buildings surround it, their lights dimmer. The metaphor is dominance through scale, not malice. Style: urban photography, long exposure, warm artificial light against cold sky.]

What does it mean for passive investing to grow?

Technically, it’s simple. More capital moves according to the index. Companies are bought not because of their performance or outlook, but simply because they are included in the index. They are not sold as long as they remain in the index.

What happens when this becomes sufficiently large?

Researchers at Harvard and the University of Chicago have proposed the “Inelastic Markets Hypothesis.” The core argument is this: the demand curve for stocks is far more inelastic than we think. Even small, mechanical inflows of capital can push stock prices beyond their fundamental value.

Passive capital is the largest form of this mechanical inflow.

There are more precise numbers. When passive ownership increases by one standard deviation, the probability of a stock experiencing a sharp rise increases by 19.4 percentage points, and the probability of a sharp fall increases by 19.2 percentage points. Considering that the historical average tail risk for typical large-cap stocks is around 23-26%, this means passive ownership alone becomes a variable that explains a significant portion of stock price volatility.

This manifests in unseen ways: in the correlation between stocks.

From 1962 to 1997, the average pairwise correlation coefficient between U.S. stocks was 5.7%. This was the probability that stock A and stock B would move together. From 1998 to 2020, after passive investing became widespread, this number rose to 13.4%. More than double.

Why is this a problem?

The logic of diversification is based on correlation. When you hold a mix of uncorrelated assets, one might fall while another holds steady. However, when large amounts of capital flow into and out of passive index funds, all stocks included in the index rise and fall simultaneously. This happens without any fundamental reason.

As a result, even if you hold all stocks, true diversification is reduced. Passive investing itself increases the overall correlation of the market.

[INFOGRAPHIC: “Passive Ownership & Systemic Risk” — A two-panel visualization: left panel shows pairwise stock correlation doubling from 5.7% (1962–1997) to 13.4% (1998–2020); right panel shows that a 1-standard-deviation rise in passive ownership increases downside tail jump risk by 19.2 pp and upside by 19.4 pp. Placed here to make the systemic risk argument concrete before transitioning to the governance section.]

However, this problem is not limited to individual investors’ portfolio losses.

The original function of capital markets is resource allocation. Money flows to good companies, and capital exits bad ones. For this mechanism to work, investors must analyze companies and reflect that analysis in prices.

As passive capital dominates the market, the proportion of people analyzing companies decreases. Even if a company announces good results, it’s sold if it’s removed from the index. If a company announces bad results, it’s held if it remains in the index. The ability of prices to reflect a company’s value, i.e., the price discovery function, weakens.

This is not just academic concern; it’s a measured reality. Quantitative research has confirmed that in stocks with high passive ownership, company-specific information is reflected in prices more slowly, and transient noise occupies a larger proportion.

4. Why Winning Five Times in a Row Means Nothing

At this point, one might object: Isn’t passive still better than active? Even if the market is transforming, isn’t it still best for individual investors to follow the market average without fees?

This objection is valid. And simultaneously, it’s insufficient.

SPIVA data is equal-weighted. Each fund is given the same weight. However, in the real world, no one puts the same amount of money into every fund. Money flows to the funds that perform well.

When recalculated using an asset-weighted approach, the numbers change. This is particularly dramatic in the bond market. On an equal-weighted basis, 54% of U.S. high-yield bond active managers fail to beat their benchmark over five years. However, on an asset-weighted basis, 86% of this asset class outperformed the benchmark.

What does this mean? It means a small number of exceptional large bond active funds are actually making a significant difference. The bond market differs from the stock market. Over-the-counter negotiations, private credit, fragmented liquidity. There is space for active managers with scale and networks to create a tangible advantage.

There’s a more important point. SPIVA doesn’t tell us how well passive funds perform. Passive funds are the market return itself. The reason active funds’ average performance is lower than the market return is not because 80% are terrible, but because of fees. If fees are reduced or eliminated, the distribution of active fund performance changes.

In 2024, there was a quarter where the top five stocks in the S&P 500 index accounted for 94% of the entire index’s return. What should active managers have done in this situation? Due to diversification rules, it was virtually impossible to hold Nvidia or Apple in proportion to their index weight. Therefore, they lost.

This is not a failure of active management, but a consequence of a market structure transformation driven by mega-cap concentration.

And that concentration phenomenon itself is not unrelated to the expansion of passive investing.

5. Three Companies Vote on the World

[IMAGE: Three massive identical towers in a financial district, shot from street level looking up. Their scale dwarfs everything around them — not ominous, but simply a statement of proportion. Clear sky above. Style: architectural photography, wide angle lens distortion, sharp contrast between the towers and the blue sky.]

When costs converge, capital also converges.

Passive funds track the same index and use the same strategies. The only differentiator is fees. It’s a logical consequence that capital flows to those offering the lowest fees.

The result of that consequence: BlackRock, Vanguard, and State Street (the “Big Three”) dominate over 90% of assets in U.S. passive equity funds. The combined assets under management of these three companies exceed $24 trillion. This figure is nearly 90% of U.S. GDP.

What this number signifies can be understood by considering shareholder voting.

The Big Three are the single largest shareholder in 88% of S&P 500 companies. They exercise 25% of the voting rights of U.S. listed companies. No government has ever had such a concentration of shareholders.

[INFOGRAPHIC: “The Big Three’s Global Ownership Footprint” — A combined visualization showing Big Three AUM (BlackRock $10.5T, Vanguard $9.3T, State Street $4.3T) and their combined ownership percentages across key markets: US equity 20%+, US vote share 25%, Ireland 19%, UK 16.4%, Australia 13%. Placed here after establishing the scale of passive AUM concentration to show its concrete governance implications.]

In traditional shareholder capitalism theory, the largest shareholder monitors and controls management. They engage in proxy fights to replace poor management. If stock prices remain low, they sell shares or directly pressure the board.

The Big Three find it difficult to do any of this.

Passive funds cannot sell shares unless the index composition changes. They have no “exit strategy.” Therefore, they have forfeited one of the most powerful means of pressuring management from the outset.

Simultaneously, the cost of exercising voting rights is one that no competitor can bear. Even if I launch a governance campaign to improve a company’s value, that benefit is shared by all passive funds replicating the same index. This is a free-rider problem. With no economic incentive, it’s rational not to engage in deep corporate oversight.

However, characterizing the Big Three’s behavior simply as a lack of oversight would be incorrect.

They actually operate large stewardship teams. And the method they’ve chosen is not proxy fights but “quiet engagement.” Before shareholder meetings, they directly meet with management to convey their demands. Management coordinates in advance to avoid proxy battles.

As a result, open conflict is rare. But that doesn’t mean oversight is effective. Rather, it means that three massive asset management firms are simultaneously shaping the governance direction of thousands of companies.

The 2017 P&G shareholder meeting demonstrated the magnitude of this power. Regarding activist investor Nelson Peltz’s bid to join the board, BlackRock and State Street voted in favor, while Vanguard voted against. The votes of the three firms diverged, and the outcome was decided by millions of shares. The voting direction of these three entities changed the composition of a giant corporation’s board.

This is a new form of power. It is unelected, unregulated, and there is no clear way to dismantle it. Passive investors entrust their money to these firms, which then use that money to influence corporate governance. Yet, these investors are largely unaware of how their voting rights are exercised.

6. South Korea’s 300 Trillion Won in ETFs, Inside the System

This story is unfolding in South Korea as well. And in several aspects, the Korean market exhibits a more extreme form than anywhere else in the world.

In October 2025, the net asset value of the domestic ETF market surpassed 250 trillion won. By the end of December, it was 297 trillion won. This is more than a fourfold increase compared to five years ago. And within this market, the number of registered ETF products exceeds 451, making it the largest in Asia by far.

[INFOGRAPHIC: “Korea ETF Market: The 300 Trillion Won Era” — An area chart showing Korean ETF AUM growth in KRW trillions from 2015 to 2025 with milestone markers at 100T, 200T+, and 297T, paired with a horizontal bar chart showing the top 4 asset managers’ estimated market share (Samsung/KODEX ~45%, Mirae/TIGER ~33%, KB/RISE ~12%, Korea Investment/ACE ~7%). Placed here to contextualize the Korean market’s scale and concentration dynamics.]

If you read the number “451 products” differently, it means: investor choices are dispersed. KODEX 200 and TIGER 200 replicate the same KOSPI 200 index. The only distinctions between these two products are fees and brand trust. Yet, almost every asset manager launches their own version.

This fragmentation means liquidity dispersion. As capital is split among multiple products replicating the same index, the liquidity of each product decreases, and the spread widens. Investors end up paying higher trading costs for buying the same index.

But there’s a more fundamental question.

A significant portion of Korean ETF funds comes from pension accounts. The structure of retirement pension and personal pension funds flowing into ETFs has been established with tax benefits. These funds have a different nature. They are not for short-term gains but are funds for retirement decades later.

What does it mean for this long-term capital to enter ETFs that simply replicate market indices?

In the Korean KOSPI index, Samsung Electronics accounts for tens of percent. Buying KODEX 200 is essentially not much different from holding a large amount of Samsung Electronics and a small amount of everything else. It looks like diversification, but it’s actually significant concentrated exposure.

For global ETFs, the opposite problem exists. If you buy an S&P 500 ETF, the weight of the seven major U.S. tech giants approaches 30%. In 2024, these stocks accounted for most of the index’s return. What if that’s not the case in 2025? The entire index will bear that shock.

It looks like diversification, but it’s not. This is the reality of modern passive ETFs.

7. The Next Revolution Will Be Quieter

[IMAGE: A single person sitting alone at a minimal workstation, one screen showing a personalized portfolio dashboard with dozens of individual stock positions. The contrast to the earlier trading floor image: instead of scale and noise, precision and quiet control. Style: lifestyle editorial, warm ambient light, contemporary minimalism.]

What is presented as the answer to all these problems? Direct Indexing.

The concept is simple. Instead of buying ETFs, you directly hold hundreds of individual stocks that make up the index in your own account. An algorithm handles rebalancing. Thanks to fractional share purchases, it’s possible even with small amounts.

What differentiates this from mere ETFs is that customization is possible. You can exclude certain sectors, adjust weights, or apply your own ESG criteria. Most importantly, you can optimize taxes according to your personal situation.

In the U.S., major asset managers are already competing to get ahead in direct indexing services. BlackRock acquired Aperio, and Vanguard acquired Just Invest. In Korea, as fractional share purchases become common and pension asset sizes grow, demand in this direction is forming.

Does direct indexing solve the aforementioned problems?

Only partially.

Market-wide synchronization issues are not resolved. Ultimately, if it’s based on the same index, liquidity concentration and weakened price discovery will still remain.

However, it’s a significant advancement from the perspective of individual investors. Especially in terms of Tax-Loss Harvesting. ETF structures offer significant tax deferral benefits, but they are managed at the fund level. With direct indexing, realized gains and losses can be managed at the individual account level.

And the issue of voting rights is also different. Because these are directly held shares, investors can, in principle, exercise their voting rights themselves.

Currently, direct indexing still has high costs and complex operational structures. It’s difficult for ordinary individual investors to access. However, as technology advances and algorithmic costs decrease, it’s possible it will become as mainstream as ETFs are today in 5 to 10 years.

Revolutions come quietly. If the first revolution was “Buy the Index,” the second revolution will be “Own the Index Directly, Your Way.”

8. Can the Market Digest the Revolution?

How can we prevent liquidity concentration in the closing auction?

One suggestion is to pilot a Random End mechanism, where the closing time is randomized. If you don’t know exactly when the market will close, the incentive for all passive funds to dump their orders simultaneously is reduced. This has been experimentally implemented in some European exchanges.

How should we address the issue of voting rights concentration?

Mandatory pass-through voting is being discussed. This means passive funds must pass voting rights directly to their fund holders. While technically complex and limited by low participation rates from small investors, the direction is correct.

In Korea, tax support for activating direct indexing also needs discussion. Expanding the scope of consolidated capital gains tax on individual stock holdings within pension accounts is one direction.

However, for these policy proposals to work, there first needs to be an awareness that a problem exists.

And that awareness is not easy. The problems of passive investing do not manifest dramatically.

Weakened price discovery doesn’t suddenly lead to a crash. When liquidity is concentrated at the close, individual investors don’t immediately feel it. When the Big Three exercise their voting rights, there are no obvious victims.

This is a slowly unfolding structural transformation. Much like a change in a river’s course. For years, you don’t notice the difference, and then one day, you discover the riverbed has changed.

Finally

[IMAGE: A close-up of water flowing over smooth river stones, shot from above. The stones are worn down — not by any single event, but by constant gentle pressure over time. The water is clear, the motion is subtle. The image should feel neither threatening nor peaceful, simply factual about the nature of slow, structural change. Style: nature documentary photography, natural light, macro detail.]

Passive investing is correct.

This statement still holds true. Minimizing fees, replicating the market average, and holding for the long term are among the most rational choices an individual investor can make. Statistics support it, and decades of empirical evidence confirm it.

However, passive investing presupposes a market. It presupposes that the market functions properly, that prices incorporate information, and that corporate oversight is in place.

That presupposition is being shaken.

In a market where prices no longer efficiently reflect a company’s value, what is passive investing replicating? What does it mean to follow the average of a market where mega-cap stocks are concentrated in the index, irrespective of corporate performance?

There is no clear answer to this question. The benefits brought by passive investing are real, and there are hundreds of millions of individual investors who enjoy them. At the same time, the market structure transformation that passive investing cumulatively creates is also real, and who pays its cost remains unclear.

As individuals, we found a way to survive in the market. But when those methods aggregate collectively, they change the market itself.

And no one has yet seen where this changed market will ultimately lead us.

References

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