Is passive investing killing the IPO Star?

The ceremonial ringing of the bell to mark a company’s debut on a stock exchange has long symbolised entrepreneurial triumph. From the NYSE to the NZX, a public listing was once considered the pinnacle of business success—a validation of years of work, risk-taking, and strategic capital raising. For founders and early backers, an initial public offering (IPO) was both a financial milestone and a gateway to broader growth. Increasingly, however, this path is being abandoned. The IPO, once the gold standard for exits, is falling out of favour across the globe.

The decline in IPO activity is not confined to a single region. It reflects systemic changes in capital markets, investor behaviour, and regulatory frameworks. The reasons are varied and interlinked. Overly complex and often poorly implemented regulations have created significant barriers to entry. Meanwhile, persistently low interest rates and the rise of massive private equity (PE) and private credit funds have enabled companies to remain private for longer, often indefinitely. Consider the examples of OpenAI and SpaceX—multi-billion-dollar enterprises with no immediate need or desire to go public.

Regulatory failure or market failure?

The structure of public markets themselves must however also bear scrutiny. Are they still fulfilling their fundamental purpose: to efficiently allocate capital toward innovation and productive enterprise? Increasingly, that mission appears compromised. As passive investing becomes the dominant force, some argue that the mechanism of capital allocation has become distorted. As one Sanford C. Bernstein strategist (in)famously quipped, “passive investing is worse than Marxism.” Hyperbole aside, the underlying concern is worth considering: are index-driven strategies undermining the health and dynamism of equity markets?

At its core, a functioning capital market should reward strong, innovative businesses by directing capital their way, while punishing weaker ones by withdrawing it. Price discovery—the ability to accurately assess the value and potential of a company—is central to this process. But in a world increasingly driven by passive capital flows, these signals can become muted or misdirected. Passive strategies allocate funds based on size and index inclusion, not on a company’s merits or growth prospects. As a result, today’s giants continue to grow, while tomorrow’s innovators struggle for recognition and funding.

The global decline in IPOs

The decline in IPOs became evident in the early to mid-2010s. This was paradoxically a period of booming equity markets, fuelled by low interest rates and abundant post-GFC liquidity. Yet instead of a flood of new listings, markets saw a steady contraction. Many firms chose to stay private, while others preferred to be acquired. Even the record-breaking year of 2021—driven by a wave of speculative SPACs—proved an anomaly. The subsequent collapse in 2022, with U.S. IPOs plunging to 180 from over 1,000, revealed the fragility of that surge. In 2023, the number fell further to 154. While 2024 saw a modest recovery to 225, the long-term trajectory remains downward.

London offers an even starker illustration. In 2023, fewer than 20 companies listed on the main market—the weakest showing since the GFC. By 2024, the capital raised by new listings was just 5% of the total raised in 2021. Once a magnet for global issuers, the London Stock Exchange has now slipped behind Malaysia and Oman in the global IPO rankings.

Across the European Union, listings are also in retreat. Between 2010 and 2018, the number of listed firms declined by 12%, despite economic growth. Major exchanges, including Germany’s Deutsche Börse, have seen sporadic large listings—often spin-offs or partially privatised state assets—but the mid-sized companies that once formed the backbone of equity markets are increasingly staying private.

In Asia-Pacific, the story is similar. Singapore’s SGX saw only four IPOs in 2024, raising a pittance on its secondary board. Australia’s ASX, traditionally a hotspot for mining and small-cap listings, hosted just 45 IPOs in 2023—well below the five-year average of 120. The total number of ASX-listed companies has declined over the past decade, as delistings outpace new entrants.

Can you get price discovery from price-agnostic investors?

This global IPO drought cannot be fully understood without examining the transformation of investor behaviour. Passive investing has reshaped how capital is deployed. Once, traditional stock-picking funds were the primary buyers of IPOs. Fund managers met with management, evaluated the opportunity, and provided price-sensitive capital. Today, index funds—by design—ignore IPOs until they qualify for inclusion, which may not happen for many months, if at all.

Passive indexing may be cheaper but that's because active management has positive externalities that benefit the whole market, and if no one is willing to pay for active management those benefits will disappear.

This matters because the majority of passive funds are not equipped to support early-stage public companies. Inclusion in benchmarks like the S&P 500, MSCI World, or FTSE Global Small Cap only comes after a company meets strict criteria for size, liquidity, and often profitability. For most IPOs, especially small- to mid-cap offerings, this means missing out on a significant source of demand. With active managers losing assets to passive strategies, there are simply fewer buyers available to support new listings.

The U.S. Securities and Exchange Commission has acknowledged that the shift to passive strategies contributes to the decline in small-cap IPOs. Academic research supports this view: passive capital does not participate in capital formation in the same way active capital does. The result is fewer listings, lower liquidity, and weaker price discovery—particularly for less prominent companies.

Private versus public markets

This dynamic helps explain why many promising businesses prefer to remain private. Private equity has flourished in parallel with the rise of indexing. Global PE assets under management grew from $1.8 trillion to $2.5 trillion between 2012 and 2017 and have continued to rise. Private investors can now offer capital on favourable terms, with fewer disclosure requirements and less scrutiny. Companies that once would have gone public at a $1 billion valuation are now raising private capital at $10 billion or more.

The consequences are far-reaching. Public investors, including retail savers and pension funds, are being excluded from the most dynamic phase of business growth. By the time these companies reach public markets, much of the value creation has already occurred. The public equity universe is becoming narrower, older, and more concentrated.

For those companies that do list, the IPO process has become more challenging. With limited demand from long-term investors, underwriters must often price offerings conservatively. This can lead to strong aftermarket performance, as seen in the UK and Australia in 2024, where IPOs delivered solid returns. But it also introduces volatility. With fewer analysts and dedicated investors covering new stocks, price movements can be exaggerated. Important information may take longer to be reflected in share prices, increasing the risk of mispricing and abrupt corrections.

Index effects, concentration risks and other ‘benefits’

Moreover, companies that eventually enter major indices may experience short-term distortions in their share prices due to sudden inflows from passive funds. This “index effect,” while less pronounced than in previous decades, still skews valuations and creates artificial demand. Conversely, companies that remain outside the indices struggle for visibility and capital.

This raises broader concerns about market structure. Passive investing channels capital toward the largest companies, often regardless of fundamentals. This has contributed to extreme concentration in equity indices. In the U.S., the so-called "Magnificent Seven" technology giants now dominate the S&P 500 – using their immense size and highly priced stock to gobble up businesses that would be attractive as listings themselves. In Australia, the Commonwealth Bank enjoys a similarly outsized position. As more money follows the index, these companies become ever more dominant—a self-reinforcing cycle that can disconnect prices from economic reality.

None of this is to suggest passive investing is inherently flawed. It has democratised investing, lowered fees, and delivered market-like (but never market-beating) returns. But capital markets depend on a balance between passive and active participants. Active investors are essential for discovering value, supporting new companies, and maintaining market efficiency.

Some policymakers and regulators are beginning to take note. In the UK, regulatory reviews have explored ways to incentivise active management and ease the burden on new listings. In the U.S., efforts are underway to streamline disclosure requirements for small issuers and reduce the disincentives to going public. These reforms recognise that public markets must remain attractive if they are to play their role in supporting innovation and inclusive wealth creation.

What’s next for public markets?

Ultimately, the health of the IPO market is a reflection of the broader capital market ecosystem. A system dominated by passive flows cannot function without a robust core of active investors willing to take risks, form judgments, and support the next generation of public companies. If we allow that core to erode, we risk turning public markets into static mirrors of the past, rather than dynamic engines for future growth.

The current IPO malaise is not caused solely by passive investing. Regulatory overreach, the rise of alternative funding sources, and changing corporate preferences all play a role. But the externalities of index-driven capital flows must not be ignored. Markets that fail to allocate capital efficiently, that no longer reward innovation or support growth, ultimately fail all participants. If today’s capital markets are built to reward only size and incumbency, they will struggle to nourish tomorrow’s leaders. And that is a loss none of us can afford.

Matt Hardwick is a Business Development Manager at Octagon Asset Management

Disclaimer: This article has been prepared in good faith based on information obtained from sources believed to be reliable and accurate. This article does not contain financial advice. Some of the Octagon portfolios own securities issued by companies mentioned in this article.

Octagon Asset Management is the investment manager for Octagon Investment Funds and the Summer KiwiSaver scheme.