March 26, 2026

When the Crowd Becomes the Market

by Ewen Emmerson

in Insights Research

There is a question that has quietly moved from the fringes of academic finance into mainstream portfolio discussion: what happens to markets when passive investing becomes the dominant force within them?

A recent paper by Michael Green, Hari Krishnan, and Stephan Sturm, circulating on SSRN, attempts to answer this with a formal mathematical model. We think it is worth reading, even if some of its conclusions sit at the more theoretical end of the spectrum.

The core argument

The authors build a model for equity market capitalisation that incorporates passive share as a key variable. Their central claim is that passive funds, by design, do not make decisions based on fundamental value. They simply put money to work as it arrives. This is not a controversial observation. What is more striking is their finding about what this means at scale.

In a market where active managers still represent a meaningful proportion of trading, they serve a stabilising function: when prices move away from fundamental value, active buyers and sellers push them back. The authors call this “mean reversion.” Their model shows that this stabilising force weakens as passive share rises, because there are fewer active participants left to do the correcting work.

The mathematics suggest that once passive share reaches roughly 65%, market volatility may begin to increase sharply. Beyond 87%, the model shows volatility growing at a cubic rate. These are not small effects. The authors acknowledge that central bank intervention and other real-world mechanisms would likely prevent the most extreme theoretical outcomes, but the direction of travel in their model is clear.

What does this mean in practice?

We are, by most estimates, somewhere around 50 to 55% passive share in the US equity market today, with the trajectory pointing higher. The paper’s simulations, run from a 1994 starting point, suggest that the period we have lived through of rising markets and contained volatility is in part a story of consistent dollar inflows supplementing passive demand. That tailwind does not go on forever.

The practical concern is not a sudden collapse but a structural change in the character of market behaviour: wider swings, slower recovery from drawdowns, and a weakened connection between price and underlying value. For long-term investors, that has meaningful implications for sequencing risk and for the value of active management in portfolios.

BCM’s perspective

We have long held the view that the case for active management rests not on outperformance in every period but on its role in risk management and in navigating regimes where passive exposure alone carries uncompensated risk. This paper adds a rigorous, if sobering, dimension to that argument.

It also reinforces our preference for building portfolios with genuine diversification across strategies, geographies, and asset classes rather than relying on broad market beta as the primary engine of return. If the mechanism underpinning index stability is itself becoming less reliable, then the composition of a portfolio matters more, not less.

We are not sounding an alarm. Markets remain functional and equity risk premiums remain intact. But we believe thoughtful investors should understand the structural forces at work beneath the surface of what has been a remarkably benign period for passive strategies.

As always, we welcome the opportunity to discuss how these considerations apply to your individual portfolio.

This article is for information only and does not constitute personal advice or a recommendation to buy or sell any security, fund or index. The value of investments can go down as well as up, and you may get back less than you invest. Past performance is not a guide to future returns. If you are unsure as to the suitability of any investment, please seek advice that takes your personal circumstances into account.