IMA fund-flow figures for April, the latest available, showed sales of tracker funds were at their highest since August 2011.
The inflows followed five months of steady stock market gains, and are likely to be indicative of investors trying to take advantage of a rising market.
However, Seaton points out that the divergent fate of the different sectors in the UK market over this period shows that investors are locking themselves into underperforming areas.
"People are moving into ETFs [exchange traded funds] at exactly the wrong time," he said. "There are some very strong sector concentrations in the UK market, a huge weighting towards resources and banks."
Seaton points out that the mining sector makes up about 17 per cent of the UK market, and has done very poorly during the recent rally.
Data from FE Analytics shows that the FTSE All Share Mining index has lost 8.77 per cent over the past 12 months while the FTSE All Share has made 21.98 per cent.
Performance of indices over 1yr
Source: FE Analytics
Although the sector enjoyed the benefits of the rally until December, it dropped sharply from then on, hampering investors who held the index through a passive index fund or ETF.
Holding a tracker fund means that investors are limited in the gains they can make from the UK market, the manager warns, as active funds can avoid certain troubled sectors such as the miners.
Our data shows that it could also be a risk in the short-term if markets fall further.
The Vanguard FTSE UK All Share Index tracker made 18.49 per cent between 1 January and 22 May, before markets fell, almost identical to the 18.47 per cent made by the index.
Performance of fund vs index 1 Jan to 22 May
Source: FE Analytics
This put it within the second quartile of the IMA UK All Companies sector, as investors would expect.
However, when markets fell, passive funds significantly lagged the average active fund.
Our data shows that the Vanguard FTSE UK All Share Index lost 6.97 per cent while the average fund in the sector was down just 5.21 per cent.
Performance of fund vs index 22 May to 17 June
Source: FE Analytics
Our research recently showed that trackers made up the majority of the bottom decile of funds in the recent market sell-off.
A similar pattern emerges in the Japan, US, Asia Pacific ex Japan, and Emerging Markets sectors over the same short time period.
The main reason is that active managers can make some fairly simple sector bets in times of stress that should protect them in such sell-offs. Few active managers have significant holdings in the mining sector, for example.
There is a wider argument about whether a significant number of active funds outperform the index over the longer term, and whether it is worth investors trying to beat an index or form a portfolio made up simply of passives.
One of the benefits of holding passives is thought to be that they provide cheap diversification benefits, which should help improve risk-adjusted returns in the long-run by giving access to a number of markets that do not move in step.
However, Rob Gleeson, head of FE Research, warns that this is not necessarily the case.
The stocks that sit on top of the main indices, Gleeson points out, tend to be the same types of companies in the same types of sectors, such as utilities, tobacco and consumer durables, along with oil, gas and mining companies.
In buying a set of passives, people may think they are getting exposure to a broad universe of stocks, but in fact they are largely exposed to a limited set of companies in a few sectors of the market.
The problem is not solved by geographic diversification – by buying a basket of passives that track the stock markets of different countries.
The types of companies at the top of the various indices tend to be the same in every country – although there are some exceptions, such as Apple in the US.
This means that there are little diversification benefits to holding the different indices, particularly in such a globalised world economy where markets move increasingly in step.
The main drivers for the indices are all the same, meaning that they can be expected to do well in the same circumstances, making a mockery of the notion of diversification, which is expressly intended to avoid this.
In addition, the place the stock is listed has little bearing on where it makes its money.
The vast majority of companies listed on the London Stock Exchange are just multinationals that have found it convenient to be located here, and those in the US are those that have got a good deal to list there.
This is a process that seems likely to continue to develop in the future, ultimately meaning that investors buying a selection of passives will be invested in a largely random collection of multinationals in a few sectors that lend themselves to developing large conglomerates.
However, Gleeson says that he does not believe investors should reject passives out of hand, but that in a truly diversified portfolio they need to be held alongside active funds to avoid a bias to certain sectors and styles.
