For more than two decades, passive investing has been a humble idea successfully marketed to the retail audience. It was a set-and-forget approach, not trying to outsmart the market but simply owning it.

Now, according to a growing camp of market critics, passive funds have become something far more consequential—they are the market.

The scale is difficult to ignore. Data compiled by Apollo Global Management Chief Economist Torsten Slok shows that the three largest S&P 500 index funds now control more than $2.6 trillion in combined assets. Vanguard’s flagship S&P 500 ETF (NYSE:VOO) recently crossed the $1 trillion mark on its own.

The trend means that an increasing share of investment decisions no longer belongs to analysts weighing earnings prospects or debating valuations. Instead, the capital flows mechanically through index-tracking vehicles that buy stocks simply because they are in an index.

“It’s a systematic algorithm that operates off of the world’s simplest algorithm: Did you give me cash? If so, then buy. Did you ask for cash? If so, then sell,” said Mike Green, Chief Investment Strategist at Simplify Asset Management.

The Structural Limit of Price Discovery

The argument challenges a foundational assumption of modern finance. Traditional theory, popularized by Nobel laureate William F. Sharpe, ...