The ETF illusion in Swiss secondary stocks: Why passive index funds cost you returns in small and mid-caps

The ongoing shift from active capital to passive index funds (ETFs, Exchange-Traded Funds) is one of the defining trends in modern financial markets. For highly liquid megacap markets such as the S&P 500 or the Swiss Market Index (SMI), this approach is entirely rational due to extreme information efficiency.

However, as soon as investors apply this passive approach unfiltered to the Swiss mid-market – the SPI Extra (Small & Mid Caps) – the supposed cost advantage turns into a structural drag on performance. Those who blindly buy the market in the Swiss SME equity sector unknowingly load significant inefficiencies and fundamental risks into their portfolios.

Key takeaways:

• Liquidity risk: Passive ETFs force procyclical transactions in thinly traded stocks, which leads to significant implicit trading costs (spreads) during outflows.
• Quality blindness: A passive index does not filter based on fundamentals; instead, it accumulates unprofitable growth companies and highly indebted market participants.
• Information asymmetry: The low analyst coverage in the Swiss mid-market (SPI Extra) creates significant mispricings that passive vehicles, by definition, cannot exploit.
• The tax disadvantage: ETFs miss out on significant tax alpha because they cannot dynamically manage distributions from capital contribution reserves (KER) at the individual stock level.

Liquidity asymmetry: The mathematical dilemma of passive inflows

The fundamental design principle of a classic ETF is weighting based on free-float market capitalization. When an ETF receives capital inflows, the algorithm must purchase the underlying stocks exactly according to their index weighting – completely independent of the current valuation or the market liquidity of the individual stock.

In the Swiss small and mid-cap sector, this leads to a mathematical distortion. Many highly specialized Swiss industrial, tech, and healthcare gems have a considerable market capitalization, yet large portions are held by founding families or long-term anchor shareholders. The actual freely tradable portion (free float) is extremely low.

When passive billions are forced into these thinly traded stocks, the buying algorithm artificially drives prices up. This dynamic becomes critical during market corrections: if massive redemptions occur, the ETF must liquidate these illiquid stocks at any price.

The impact on returns can be quantified via implicit trading costs (C_implicit), which consist of the bid-ask spread (S) and market impact (I) in the event of insufficient liquidity:

For passive vehicles, this component explodes during volatile phases because they are forced to execute regardless of volume (ΔV). An active asset manager , on the other hand, manages order placement opportunistically, takes advantage of periods of high liquidity, and avoids stocks whose prices are distorted purely by passive flows.

The “zombie effect” and hidden concentration risks

An index reflects the past, not the future. Since the SPI Extra tracks all companies beyond the 20 SMI blue chips, a passive ETF inevitably invests in the entire breadth of the market—including structural losers, highly indebted companies, and unprofitable biotech start-ups.

• Capital allocation to unprofitable firms: A passive fund does not conduct credit analysis. Through index weighting, it finances companies whose cash flow barely covers interest expenses in an environment of more restrictive monetary policy.
• Hidden concentration: Contrary to the popular belief in “broad diversification,” a few large mid-caps often dominate the SPI Extra. As a result, despite the ETF wrapper, an investor holds significant concentration risk in a handful of individual stocks.

To illustrate these differences, a direct system comparison shows the structural discrepancies in practice:

Stock selection

• Passive SPI Extra ETF: Blind buying of all listed companies—including loss-makers.
• Active SME equity strategy: Selective focus on profitable quality leaders (stock picking).

Valuation Focus

• Passive SPI Extra ETF: Ignores the price-to-earnings (P/E) ratio and enterprise value.
• Active SME Equity Strategy: Counter-cyclical entry when significantly undervalued relative to fair value.

Liquidity Management

• Passive SPI Extra ETF: Pro-cyclical trading forced by inflows and outflows.
• Active SME Equity Strategy: Opportunistic exploitation of market illiquidity for better pricing.

Risk Adjustment

• Passive SPI Extra ETF: Acceptance of index concentration and structural risks.
• Active SME Equity Strategy: Active exclusion of value traps and over-leveraged balance sheets.

Information Asymmetry: Where active research generates real alpha

The primary reason for the efficiency of large-cap markets is the omnipresent analyst coverage. A stock like Nestlé or Apple are scrutinized by hundreds of analysts worldwide every minute. Mispricings are rare and correct themselves in fractions of a second.

In the Swiss small- and mid-cap sector, the situation is entirely different. Due to stricter regulations (such as MiFID II or FIDLEG and the associated unbundling of research fees), many major banks have drastically reduced their research capacity. Numerous high-quality Swiss companies are covered by barely two or three analysts – some fall completely through the cracks of institutional awareness.

This creates a profound information asymmetry. Since the share prices of these companies are not perfectly information-efficient, they regularly deviate significantly from their true intrinsic value.

An active asset manager generates alpha precisely here: through original primary research. Direct access to management, on-site facility visits, and in-depth analysis of supply chains and niche markets allow for the identification of undervalued gems before they are discovered by the broader market and pushed upward by passive inflows.

Tax and dividend-based restrictions

Another aspect often neglected in the Swiss context is the optimization of special distributions. The Swiss mid-market is characterized by a traditionally high dividend discipline. Many of these companies hold substantial capital contribution reserves (KER), which allow for distributions that are completely exempt from withholding and income tax for Swiss private investors.

A passive ETF bundles all these returns into a standardized fund structure. In doing so, the flexibility to manage dividend streams at the individual stock level for tax efficiency or to strategically manage timing around the ex-dividend date is lost. A direct investment mandate, by contrast, allows the asset manager to balance the portfolio precisely to maximize the net-after-tax return for the Swiss investor.

Conclusion: No compromises in the Swiss mid-market

For the long-term success of a Swiss wealth portfolio starting at CHF 500,000 small and mid caps are indispensable as return drivers due to their historical outperformance. However, holding them via passive ETFs means forgoing the most important source of return in this segment: the targeted selection of quality.

ETFs reflect the mass of the market – including all its structural weaknesses. Top-tier rankings in independent assessments (such as the renowned BILANZ investment rating) consistently underscore that in the inefficient Swiss small-cap market, only an uncompromising, active quality approach reliably separates the wheat from the chaff and provides real protection for capital.

From index clusters to an alpha portfolio: Your Swiss equity strategy

Simply buying a passive market index fails to tap into the true potential of the Swiss mid-market and unknowingly introduces fundamental risks into your portfolio.

Format Vermögen & Anlagen AG supports you at our locations in Zurich, St. Gallen, Basel and Lucerne with independent expertise to align your portfolio for genuine alpha, moving beyond standardized mass-market ETFs. As specialists in Swiss small and mid-caps, we rely on in-depth proprietary research and invest exclusively in profitable, high-quality companies. Our latest awards 2026 prove that this active selection process delivers superior long-term results.

→ Schedule your free, no-obligation initial consultation, tailored directly to your asset structure, today.

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